Customer Lifetime Value: A Review

Article excerpt

The concept of regarding customers as assets that should be managed and whose value should be measured is now accepted and recognized by academics and practitioners. This focus on customer relationship management makes it extremely important to understand customer lifetime value (CLV) because CLV models are an efficient and effective way to evaluate a firm's relationship with its customers. Assessment of CLV is especially important for firms in implementing customer-oriented services. In this paper we provide a critical review of the literature on the development process and applications of CLV.

Keywords: customer lifetime value, customer profitability analysis, shareholder value, customer equity, activity-based costing.

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Customer profitability refers to the revenues less the costs that one particular customer generates over a given period. As such, this variable relates to the supplier's value of having one particular customer, not the customer's value of having a particular supplier. In the marketing-related literature there are two temporal forms of customer profitability. In an historical sense, a customer profitability analysis (CPA) is similar to the firm's profit and loss statement. The main difference is that a customer profitability analysis refers to one particular customer, whereas a profit and loss statement refers to all customers. A historyoriented customer profitability analysis can be made at several levels. A common point of departure is to calculate the gross contribution margin, that is, sales revenue less all product-related expenses for all products sold to an individual customer during one particular period (Wang & Spiegel, 1994). Then - depending on the availability of data - sales, general, and administrative expenses traceable to the individual customer are subtracted (Cooper & Kaplan, 1991). The result of this calculation is the operating profit generated by the customer. An extension of this line of thinking is the computation of customer return on assets, that is, customer profitability divided by, for example, the sum of accounts receivable and inventory (Rust, Zahorik, & Keiningham, 1996).

Customer profitability is also referred to in a future sense in the literature. In this case, it often takes the form of the output from a net present value analysis. The output is sometimes referred to as the lifetime value of a customer (Petrison & Blattberg, 1997; Rust et al., 1996). It has been defined, for example, as the stream of expected future profits, net costs on a customer's transactions, discounted at some appropriate rate back to its current net present value. A similar concept is customer equity, which is seen as a function of the customer's volume of purchases, margin per unit of purchase, and acquisition, development, and retention costs traceable to this customer (Blattberg & Deighton, 1996; Wayland & Cole, 1997).

In today's competitive environment, marketers face increasing pressure to make marketing activities more accountable (Rust, Lemon, & Zeithaml, 2004). Findings in resent research on customer lifetime value (CLV) offer a useful framework in which marketing actions are explicitly related to financial metrics. The CLV framework is a measure of how changes in customer behavior (e.g., increased purchase, retention) could influence customers' future profits, or their profitability to the firm. The CLV framework helps bridge marketing and finance metrics

Reinartz and Kumar (2000) identified three main reasons that interest in customer lifetime value research has increased recently. First, firms are becoming increasingly interested in customer management processes, for which an understanding of the concept of CLV is a prerequisite. Second, the Marketing Science Institute has elevated the topic to a capital research priority. Third, empirical evidence is particularly scarce in the domain of CLV. …