Think You Know Customer Lifetime Value? Think Again, Says Professor Peter Fader

Look no further than customer lifetime value (CLTV), the ultimate metric for understanding your customers’ long-term worth. But beware, CLTV isn’t a one-size-fits-all solution. In this blog post, we’ll bust common myths and unveil the secrets to calculating CLTV effectively, drawing insights from marketing guru Peter Fader.

Myth #1: CLTV has a fixed horizon.

Busted! The “L” in CLTV stands for lifetime, not a measly year or two. Especially in B2B settings, customers can stick around forever. Don’t shortchange their value by imposing arbitrary limits.

Fader says: “We want to project CLTV over a very long horizon. Yes, we account for the time value of money, but ultimately, we’re looking at the big picture.”

Myth #2: CLTV is a fixed number.

Wrong! CLTV is not a one-size-fits-all number. It’s a dynamic measure that varies depending on several factors, including:

• Customer type: Are they a loyal subscriber or a sporadic purchaser?
• Business model: Is it subscription-based, transactional, or something else?
• Customer lifetime: How long will the customer relationship last?

Subscription businesses differ vastly from discretionary purchases. Each business model demands a unique CLTV approach. Consider factors like contractual obligations and purchase frequency to tailor your model.

Myth #3: The average customer exists.

Busted! Don’t get fooled by averages. The real magic lies in understanding the distribution of CLTVs. Identify your high-value “swans” and their characteristics to unlock strategic insights.

Myth #4: RFM is outdated.

Wrong!  RFM stands for Recency, Frequency, and Monetary Value. It’s still a simple yet powerful framework for segmenting customers based on their purchase history. While some might consider it old-fashioned, Fader argues that its effectiveness remains unmatched.

• Recency: How recently did a customer purchase? Recent purchases signal continued engagement.
• Frequency: How often do they buy? Frequent buyers are more valuable than one-time purchasers.
• Monetary Value: How much do they spend per purchase? Bigger transactions translate to higher CLTV.

Fader, initially skeptical, discovered the magic of RFM through complex statistical modeling. Even the most sophisticated models often collapse back to RFM, highlighting its enduring effectiveness.

So, how can you leverage CLTV to grow your business?

Here are some key takeaways from Fader’s insights:

• Focus on the long term: Don’t underestimate the value of long-term customer relationships.

• Understand your customer segments: Use RFM or other relevant frameworks to segment your customers and tailor your marketing efforts accordingly.

• Invest in customer retention: It’s cheaper to retain existing customers than acquire new ones.

• Track and measure: Continuously monitor your CLTV metrics to identify areas for improvement.

Peter S. Fader is the Frances and Pei-Yuan Chia Professor of Marketing at The Wharton School of the University of Pennsylvania. . Here’s the full conversation