Starting off with a bit of theory, the Customer Lifetime Value (LTV) metric is defined as the revenue that a business will generate from each particular customer over the length of the relationship, considering acquisition and retention costs.
This metric can also be split into actual and potential to illustrate possible growth dynamics of a relationship. As it is about predicting future earnings, it belongs to predictive analytics that forecasts the future value of any particular customer relationship.
By definition, LTV can’t be a constant, hard number, and different businesses are likely to adopt different variables for its calculation. Still, the following formula gives us a quick look at the core of LTV calculations where a company’s retention rate and average relationship ‘life expectancy’ are paramount:
LTV = gross contribution per customer x (yearly retention rate/1 + yearly discount rate – yearly retention rate)
LTV is known to be widely used in B2C industries, especially in Retail and Telecommunications. Yet if we look at B2B enterprises, we talk about LTVs worth millions of dollars per account, which poses a high significance for the business vitality. The approaches may differ too. As it was correctly pinpointed by 1to1 Media, in B2B “judgment and experience are often more useful and reliable than statistics” because of a considerably smaller number of customer accounts than in B2C where the statistical approach is more applicable.
This takes us to the area of subjective assumptions based on gut feelings of responsible employees. It’s not accidental that so many made-up terms describing the potential customer value have entered their professional language, like petty, interesting, blockbuster, you name it. Still, you can hardly imagine these highly informal definitions on an executive report.
When thinking of a unified, feasible methodology across the organization, it’s down to formalizing these gut feeling estimations within an automated, sales-related system. This happens to be the one for customer relationship management, not in the least because it already stores all the account-related details and is in a daily use by sales force. But before we get down to the practicalities of CRM-bound LTV calculation, here are some suggestions on how exactly it can help in day-to-day sales activities.
Why Measure LTV in B2B
Adding another metric to a pile of sales estimations is always daunting for sales people, especially since each time they just sense it will be somehow connected to their KPIs (and it’s often the case with LTV). So a decent justification should be in place to make them adopt it. Below we suggest three major areas where LTV can apply with a B2B company’s long-term revenue streams in mind. In each of them, CRM software can provide its inbuilt capabilities that will allow to easily sort the list of accounts by the LTV dimension in one click once LTV numbers are in the system.
Prioritizing client activities
One of the paramount potentials of LTV is in its ability to cast light over disproportional sales efforts spent both on leads and current customers. When revealing the comparative value of different customer accounts, it becomes easier to segment out the most valuable ones and prioritize sales reps’ time accordingly. For example, knowing that customer A has a $200K LTV compared to customer B with a $10M LTV will help to prioritize first nurturing and then retention activities more efficiently.
Identifying under-developed accounts
Sometimes LTV can become a true revelation helping to see more than meets the eye. As in the case with so-called under-developed accounts that seem to be pretty mediocre until their LTV is properly calculated. For example, registering only a few random sales in small batches to customer A can make no impression, yet calculating its full potential for the expected length of the relationship can actually place the account in the company’s top 20 percent, making the manager rethink the account development strategy.
LTV’s predictive nature allows tapping into a company’s market potential based on its real accounts, which means that the identified market potential is already penetrated. This can provide a holistic, multi-dimensional picture of the company’s growth potential. Some of the possible approaches include calculating the entire customer base’s LTV and that of strategic accounts, as well as comparing customer segments by regions. This can be successfully applied in decision-making where customers’ short-term value may be insufficient or even misleading.
How to Make LTV Part of CRM
As we discussed earlier, customer relationship management software is a natural place to record and use LTV along with all account-related facts and assumptions that can influence this figure. For this, the system can accommodate extra fields on customer account forms, but before that, the sales team should agree on common guidelines to align their approach. Here are some of the most critical points to consider.
Though not hard data, recorded assumptions are instrumental to LTV calculation at B2B companies, especially as we deal with highly subjective judgments. Such assumptions can cover a variety of factors, e.g. the estimated number of projects to be held with this particular lead, the expected volume of resources to be requested, an upsurge caused by the customer’s expanded market, etc. This should find its way into sales reps’ breakdown of the LTV formula, complete with descriptions and quick "justifications" of the variables. With no assumptions recorded, it may be impossible to track back a mistake or a misjudgment.
Formalized vs. participatory LTV calculation
For accounts of various sizes it makes sense to introduce two distinctive procedures of LTV calculation: the one for smaller ones that suggests a formalized approach with a simple equation in place (e.g. relationship expectancy multiplied by the estimated number of orders a year multiplied by the average order size); the other for bigger ones where judgements should rest on collectively shared opinions by a specially assigned steering committee of senior decision-makers.
Minimized conflict of interest
When introducing LTV as a metric that is used to measure sales force performance, it’s critical to set it realistically, if set at all (as sales reps would likely record lower LTVs to balance their quota fulfillment). Going back to the overview by 1to1 Media, in practice, the ideal ratio would be to set the quota at 80 percent of the actual LTV and 60 percent of the potential LTV, which gets sales reps to work on it more willingly.
A heads up to challenges
Mitigating the human factor in LTV calculation can be its hardest challenge, and it can have even more far-reaching implications in these particular situations:
- New markets, where sales reps can just have no experience to base their "gut feeling" about LTV on.
- Bulk-raising LTV when a new product is up, where the new LTV can only be a very approximate reflection of new opportunities.
- Assessments covering different geographies or customer segments with incompatible variables, which therefore can’t be compared due to their disparity. This could be mitigated by working out a unified calculation method on a senior level.
For many B2B companies, introducing the Customer Lifetime Value metric can become a cornerstone of the corporate CRM policy. Not accidentally, customer relationship management software is home to LTV calculations, and with a bit of uplift from a CRM consultant, the system can take just the necessary shape to store, analyze and report on this information.
Drawing the bottom line, LTV may have its downsides, like being heavily based on human judgment and prone to challenges in areas with a high level of uncertainty. Still, with its potential to define individual customers’ contributions to the seller’s revenue streams, to help with prioritizing and setting ambitious but realistic goals, LTV is what can help sales forces identify new opportunities for account development and thus business growth along the way.