Customer lifetime value has three main components:
- The acquisition cost of customer
- The annual profit of customer
- And the lifetime of the customer to the firm
The annual profit of a customer
The main component of the customer lifetime value formula is an understanding of what profitability is generated from each individual customer on average.
In simple terms, what is known as “customer profit" is the revenue generated by a customer over a year, less the direct costs of providing that product or service to the customer, less any costs of retention or other forms servicing.
In terms of customer revenue, we consider the array of products and services that are purchased by the consumer – we are not looking at it on an individual product basis. For example, a bank would consider the revenue they generate from an individual customer based on their credit cards, any loans, any fees charged, and so on.
Direct costs of those ones associated with the provision of the product. For example, if we were selling chocolate bars at $2 each, then the costs of production of the chocolate bar and logistics costs (transport and storage and delivery) would be included in the overall cost estimation.
The other component of cost to consider is servicing or retention costs – these are probably more applicable to service firms, rather than manufacturers.
The customer lifetime value needs to consider the full range of costs, because these will vary by customer segment – which is also discussed in a separate article on this website. If we take a legal firm as an example, they are highly likely to have a lot of support staff, provide newsletters and additional information, and perhaps indulge in hospitality (such as, business lunches and free seminars) for their business clients. However, they are likely to incur these costs to such extent for individual customers.