Often firms concentrate the entire marketing effort on finding new customers and making that first sale. This strategy ignores the fact that it’s easier and more valuable when a firm dedicates a significant portion of its marketing budget and effort to serving existing customers. A focus on existing customers helps optimize customer lifetime value.
Customer lifetime value
So, what is customer lifetime value?
According to Qualtrics, customer lifetime value or CLV is:
Customer lifetime value is the total worth to a business of a customer over the whole period of their relationship. It’s an important metric as it costs less to keep existing customers than it does to acquire new ones, so increasing the value of your existing customers is a great way to drive growth.
CLV consists of both keeping existing customers coming back for more and increasing the average order value (AOV) for each purchase. We can also talk about CLV as a function of the share of wallet, and existing customers tend to spend a higher percentage of their disposable income on brands they trust and with whom they have good experiences.
Harvard Business Review has this to say about the importance of share of wallet over plain customer loyalty. HBR defines the share of wallet as:
[the] percentage of a customer’s spending within a category that’s captured by a given brand, or store or firm. Customers may be very satisfied with your brand and happily recommend it to others—but if they like your competitors just as much (or more), you’re losing sales. Making changes to increase satisfaction won’t necessarily help.
Thus, it’s not enough to just get repeat business. Your goal as a marketer should be
- retaining customers
- increasing your share of wallet from existing customers
- motivating customers to increase their average order size
Why focus your marketing budget on existing customers
Sometimes marketers approach marketing their brand as a zero-sum game. And, that’s not reality. Rather than a zero-sum game where customers either purchase your brand or that of your competition, existing customers approach a new purchase with knowledge, experience, and attitudes about your brand that are richer than these same cognitions relative to untried brands. Given that most consumers are risk-averse, or, at a minimum, prefer known brands versus unknown brands, you have an “in” with existing customers.
That’s why savvy marketers build relationships with customers rather than just move on to the next prospect after a successful sale.
In addition, marketing to existing customers is up to 5 times less expensive than converting a prospect into a customer.
Marketing relationships are valuable because existing customers have established attitudes regarding your brand and, assuming you’ve done a good job of providing superior products and customer services, you’ve done the hard part, making them more likely to repurchase from you in the future whether that purchase is a repurchase of the same product or other brands in your portfolio.
This is the concept of customer lifetime value — that customers should represent sale after sale, not just a single sale. A great example of a firm maximizing customer lifetime value is Apple.
All the products developed by Apple fit a particular type of consumer who wants products that are innovative, stylish, and easy to use. By focusing on creating a community of satisfied Apple users, Apple sells them first one product, then another, such as a computer, then an iPod and an iPhone, or a tablet.
Implementing customer lifetime value?
Customer lifetime value is a function of a customer’s loyalty to your brand as well as the costs associated with serving that customer. For instance, a customer who returns a high percentage of the products purchased increases your costs, especially in a digital world where the shipping costs often fall to the e-commerce site instead of the buyer. That’s why companies like Amazon rate customers based on their return rate.
Calculating the value of different classes of customers is accomplished by assessing the marketing costs associated with attracting and maintaining a particular class of customer against the sales you’ll make to that customer over time. I wrote a post giving step-by-step instructions for calculating customer lifetime value you can use to determine which customers to keep and which customers aren’t worth your continued support.
Now, firing customers with low CLV is a little tricky since people talk, and “fired” customers tend to share negative messages about your brand. Finding a way to achieve high CLV from your customers while avoiding negative attitudes requires balance and tact. For instance, banks handle low CLV customers by charging fees. Hence, high CLV customers get free check printing, private bankers, and other perks, while low CLV customers either pay for the extras or don’t get them at all. The same is true for airlines that treat frequent flyers differently than the occasional traveler.
Now, you might wonder about the legality of the disparities between how some customers are treated compared to other customers– think about anti-monopoly or antitrust regulations. Firms get around these regulations by treating customers differently based on actions by the customer and every customer who performs certain actions gets the perks. Hence, every frequent flyer who meets the milage criterion gets special treatment.
Why use customer lifetime value?
Customer lifetime value helps maximize your profits. Calculating CLV shows you which customers buy more of your products and services. It also shows you which customers are more expensive to serve. For instance, many businesses have a class of consumers who are more expensive to serve — maybe they make frequent returns (as discussed earlier) or maybe they expect free services to satisfy their frequent complaints. Not only do these customers represent higher costs, but they also have the potential to infect other customers.
Optimize customer lifetime value in the age of digital marketing
Certainly, optimize customer lifetime value supports the success of businesses in the digital age. Digital marketing allows businesses to build a community that enhances brand loyalty through interactions among community members and drives customer lifetime value. But, customers create additional value across social media.
Here are specific ways members enhance their CLV:
In social media, customers create additional value not only through buying additional products but through spreading the brand message through their social networks. Each time a customer posts a favorable mention of your brand, that message spreads through their connections to reach new potential customers. Because members of a social network share tastes, attitudes, and lifestyles, at least to an extent, your message reaches other folks in your target market [see below]
Also, customers create value when they provide support to the brand. By answering questions about the use of your product, suggesting additional usage for the product, and other types of support for people who own the product or are interested in buying the product, community members create value for the brand. Some members go so far as to solve problems for other buyers that otherwise require time spent with your customer service folks. In some communities, members even go so far as to reduce cognitive dissonance or reduce the impact of product failure experienced by other members.
For instance, I did some work for Disney in the past. Bad weather caused the park to close for a day or so and forced guests to leave resort properties. A community member complained bitterly about the inconvenience and loss of his vacation. Disney sent an autographed picture of Mickey as compensation, which only threw fuel of the fire of his anger. When he shared his negative feelings with the community, several members told him it wasn’t so bad, after all, bad weather wasn’t Disney’s fault. One member even went so far as to point out the value of the autograph and how he would be thrilled with such a gift.
These contributions from community members that provide benefits to the brand, mean firms must modify their calculations of customer lifetime value to reflect the additional value created by community members when they perform actions like those listed above that go beyond actual sales of the product. Influencers are the most important community members and deserve a much higher CLV based on their engagement with the brand.
Because customer lifetime value is affected by both sales to certain customers and their ability to impact the purchases of others, a different assessment of customer lifetime value is necessary for firms wishing to optimize customer lifetime value and, thereby, improve performance. This is why brands seek those influential about their products — they recognize the value of these recommendations.
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