Advantages and Limitations of the Simple CLV formula

 

As discussed on this website, there are two approaches to calculating customer lifetime value. The first approach is to use a relatively simple formula – which is discussed in detail with examples in the article on the simple CLV formula.

The other approach is a little bit more complex and is best calculated using the free Excel template available on this website. However, details and examples on using this CLV formula discussed under the article on the main CLV formula.

It is this second approach that is generally recognized as the formal and more accurate approach to calculating customer lifetime value. But it is a little bit cumbersome to calculate and generally does require the assistance of an Excel spreadsheet. Therefore, there are times when using the simplified customer lifetime value formula is more appropriate and/or more efficient.

The main advantages of the simple customer lifetime value formula are:

  • It can be calculated very quickly and simply,
  • It can be more easily explained to management, allowing you to more efficiently communicate the concept of customer lifetime value and how it relates to financial and corporate objectives,
  • It is generally reliable for short-term customer loyalty situations
  • It is also generally reliable where annual customer profit contributions are relatively flat,
  • It can be effectively used as a relative measure for tracking customer lifetime value trends over time, and
  • You can be utilized for comparing the (profit) value of different customer segments.

The main limitations of the simple CLV formula are:

  • It does not measure changing customer revenue and costs over time – making it inappropriate for a firm that is pursuing share-of-customer marketing goals,
  • It assumes that the retention rate (loyalty rate) is stable and does not change over time – again making inappropriate for firms pursuing increased loyalty marketing goals, and
  • It does not apply a discount rate to future customer revenue and costs, resulting in customer lifetime value being overstated to the firm.

Which CLV formula to use?

As discussed in the article of when to use the simple CLV formula, this more straightforward formula is appropriate in certain situations. However, as an organization moves towards more professionalism and a greater focus on marketing ROI, the full customer lifetime value formula should be utilized – which is available by using the free Excel template on this website.