Customer Lifetime Value (LTV) can be both retrospective, based on the historical sales data, and predictive, aimed at defining the potential value of each customer relationship. While the former is good for general reporting, it is the latter that offers an advanced guidance into business development. Knowing how much each of your customers is worth means making more careful, weighted decisions in marketing and sales. Ultimately, this is what brings up well-balanced strategies when it comes to investments into growing the customer base, both vertically and horizontally, versus expected monetary returns.
LTV can be both retrospective, based on the historical sales data, and predictive, aimed at defining the potential value of each customer relationship. While the former is good for general reporting, it is the latter that offers an advanced guidance into business development. Knowing how much each of your customers is worth means making more careful, weighted decisions in marketing and sales. Ultimately, this is what brings up well-balanced strategies when it comes to investments into growing the customer base, both vertically and horizontally, versus expected monetary returns.
How it differs in B2B
LTV is a key metric in such B2C industries as retail and telecommunications, where leading market players in these domains have long tapped into measuring their customers’ LTV on a regular basis, albeit it still borders with many challenges of figuring out the approach (and approaches are many; some include complex computation via a designated software). Whatever the adopted formula for calculating predictive LTV, it always deals with predicting two major variables: expected retention and estimated profitability. In financial terms, this translates into the volume of repeat sales you can make throughout a relationship.
B2C enjoys its statistically sound scale of customers, highly predictable variables at play and quite a narrow fluctuation between a lower and upper thresholds: say, a mobile plan subscriber can bring from $360 to $960 over a 2-year contract, period. B2B enterprises have harder times predicting LTV: their customer bases are typically smaller, yet the value of the relationship grows exponentially with each new order, making the range of the lowest and highest possible LTV enormous: for a carrier’s contractual relationships with a freight forwarding company, it can be anywhere between $50,000 and $1,000,000.
On the seesaw
As this methodology deals with estimates, not historical data, assumptions abound. And as assumptions largely depend on the patterns of human thinking, this takes us on a peculiar seesaw with either far optimistic or outright pessimistic ends. Depending on where you stand on this LTV seesaw, you either go an extra mile and invest into building a relationship or make do with a one-off order with no prospect of another. In case of miscalculation, you may find yourself at loss:
- You’re too optimistic, and the cost of your customer relationship management efforts outweigh the actual profit you make in the relationship.
- You’re too pessimistic, and you are bound to miss a few lucrative opportunities, associated with an underestimated accounts, to your competitor.
We know from behavioural economics that not all financial decisions are made rationally. Humans are prone to biased thinking when affected by certain psychological and sociological factors, which makes the prospect of realistic calculations of predictive LTV even less likely. Based on our consulting practice for B2B clients in IT, transportation, biotechnology and others, we have come to understand that the pessimistic vs. optimistic model of LTV estimation should be counter-balanced with the variable of caution to get a more accurate and safer result. The higher the caution for a business, the more this business is inclined to stick to the lowest possible LTV in its forecasts. So the formula will be:
Realistic LTV = P+0-P/C,
where P is the pessimistic (lowest possible) LTV, O is the optimistic (highest possible) LTV, and C is the degree of caution applicable to this particular business.
This is how it works. Let’s take the predictive LTV range of $200,000-1,000,000 for a business with a medium caution and calculate the realistic value.
Realistic LTV = 200,000+1,000,000 -200,000/2=$600,000
Equipped with this figure, the business will be able to adequately allocate customer acquisition and retention efforts without overlooking a profit-making potential of a relationship.
Did you find it helpful? Share your experience with LTV calculations in comments.