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By Arun Kottolli

Customer is the greatest asset to any business, specifically, the current customers who will remain as customer in future also. Its common knowledge that the customer is the basic reason for the company's existence. The importance of customer is known to everyone in business, but what's surprising is the fact that many business do not know the value of the customer in terms of Rupees. By customer value, I mean the lifetime value of the customer.

What's Customer Lifetime Value?

Customer Lifetime Value (CLV) is defined as the present value of the total profit you will realize, in monetary terms, from your average customer during the entire period that customer does business with you.

In other words, customer lifetime value is the present value of the potential contribution of your customers to your business over a period of time.

Calculating your Customer Lifetime Value:

To calculate CLV, you need to know three things, First, the estimated annual profits from that customer. Second, the duration of the business relationship with that customer. Third, the current discount rate. If you do not have the actual figures, then you will have to estimate. As the Customer Lifetime Value will have a significant impact on your bottom line, my advice is that you be prudent and conservative in your estimation.

Let's say you have a customer who generates Rs3000 profit every year for next 10 years . If the current discount rate is 8%, then the customer life time value will be:

CLV = ⁱ⁼¹⁰ S_i 3000/1.08 ⁱ = 20,130.25

CLV = 3000/1.08 + 3000/1.08 ² + 3000/1.08 ³ + 3000/1.08 ⁴ + 3000/1.08 ² .... 3000/1.08 ¹⁰

This means that the customer is worth Rs 20,130 to you today!!

Importance of understanding Customer Lifetime Value

"Customer lifetime value is not just a number; it is a way of thinking and doing business"

Knowing and fully understanding the customer lifetime value changes the business perspective to a great extent. To begin with, company can use it to estimate the current value of all its customers. By knowing the current value of the customer, you can then segment customers into different categories. Segmenting helps to concentrate more on the profitable customers. For instance, discount brokerage company Charles Schwab answers its best customer's phone calls within 15 seconds while other customers have to wait for as long as 10 minutes to have their calls answered. Once customers are segmented based on profitability, you can tailor your offerings to various segments.

Segmenting Customers

Today, companies around the world are increasingly segmenting their customers in order to increase profitability. Segmenting helps companies to tailor their offerings to each of the segment. One of the common ways of segmentation is based on loyalty & profitability

After segmenting customers, companies tailor their offerings, marketing strategies to convert existing customers to become more loyal and more profitable. Segmenting helps companies to allocate their marketing resources based on the customer value. Customer lifetime value give a formalised depiction of a long-term view of the customers and gives a better picture of what the company is going after.

Increasing customer retention.

Traditionally, most marketing theory an practice centers on attracting new customers rather than retaining existing ones. Since acquiring a new customer costs a lot more than retaining one, it is wise to measure customer satisfaction regularly. The key to customer retention is customer satisfaction. A highly satisfied customer stays loyal longer, buys more products or services, pays less attention to competing products or services, is less sensitive to price, offers product or service ideas to you, and costs less to serve than new customers.

To improve customer retention, you need to analyse customer defection. Analysis can start with the internal records such as sales log, point of sale receipts records etc. Next step would be to use market research such as bench marking studies and statistics. While analysing customer defection, some basic questions to ask are:

1. What are the retention norms for our industry?
2. What is the relationship between retention rates and changes in prices?
3. Where to lost customers go for the same products or services?
4. Is there a cyclical pattern for customer defection?
5. Does defection rate vary by region or sales representative or distributor?
6. Which company in our industry has the highest retention rate?

Increasing customer lifetime value

By definition, customer lifetime value is the present value of the future profits. To increase customer lifetime value, one has to increase the profits generated from that customer. The most common ways to achieve that is either to up-sell or to cross-sell to the same customer, i.e., make your existing customers buy more products from you and buy it more often.

It is noted that highly satisfied customers often recommend it to their friends, relatives and others. This recommendation results in new customers and referral sales. The cost of acquiring new customers by referrals is substantially lower than traditional methods. In the long run, high customer satisfaction results in lower customer acquisition costs and higher margins, thus increasing customer life time value.

Customer lifetime value and Indian IT services sector.

Customer lifetime value concept was developed for product based company. However the same concepts apply equally to IT services also. In case of IT services, the customer satisfaction is highly dependent on the person performing the service. Therefore companies must ensure that all employees understand and work for maximising customer satisfaction. To help employees understand the value of the customer, every employee dealing with that customer must be made aware of that customer's lifetime value, customer segment and methods to improve the customer lifetime value. Indian IT services companies can gain a great deal by up-selling and cross-selling of additional services. Indian IT companies can now offer additional services like management consulting, Business transformation services and other business services.

IT consultants interact with customers on regular basis, they will play a key role in increasing the customer lifetime value and thereby improving the profitability. To realise this potential, Indian companies must invest in training their consultants in basic marketing functions, make them aware of all the other services they can offer. A little investment to develop some business skills in addition to technical skills will help boost Indian IT services company increase its profitability, build competitive advantages and sustain high growth rate.