8.2 CLV Measurement Approach
CLV is defined as the ‘sum of cumulated future cash flows – discounted using the weighted average cost of capital (WACC) – of a customer over their entire lifetime with the company’ [1]. In this regard, CLV can also be referred to as the net present value of future cash flows from a customer. Increasingly, adoption of CLV and CLV-based strategies are being well accepted by marketing practitioners, due to its forward-looking component, unlike the traditional measures of profitability.
When computing CLV, managers have to consider the setting in which the customer purchases are being made, that is, contractual and non-contractual. A contractual setting is one where the customers are bound by a contract such as a mobile phone subscription. On the contrary, in a non-contractual setting the customers are not bound by a contract such as grocery store purchases. That is, in a contractual setting, the firm gets fixed monthly revenue through the subscription and observes when churn occurs (i.e., when the subscription is cancelled). But the observation of the churn would be missing in a non-contractual setting. Therefore, these differences will have to be included while computing CLV. To cover both situations, CLV can be expressed in the following form:
where:
CLVi = lifetime value for customer i
= predicted probability that customer i will purchase additional product(s)/service(s) in time period t
= predicted gross contribution margin provided by customer i in time period t
= predicted marketing costs directed toward customer i in time period t
t = index for time periods, such as months, quarters, years, and so on
T = the end of the calibration or observation time frame
r = monthly discount factor
Base GC = predicted base monthly gross contribution margin
Equation 8.11 can also be written as follows:
As is evident from Equation 8.1, this formula can be applied in both the contractual and non-contractual settings. Now, let us look how it works in each of the settings.
In a contractual setting, the first term in Equation 8.1 or the baseline CLV corresponds to the constant gross contribution that the customer is going to give to the firm. This could be on a monthly, quarterly, or annual basis depending on the time frame of the subscription. This term includes the marketing cost to retain the customer at the current level of Base GC. The second term in the equation corresponds to the predicted net present value of future purchases by the customer at a particular time period. The third term corresponds to the additional marketing costs incurred to sell more product(s)/service(s) to the customer. The final value of these three components would yield the CLV in a contractual setting.
In a non-contractual setting, the first term in Equation 8.1 would not be valid as there is no constant flow of base income from a customer on a periodic basis. In short, there is no assured income due to subscriptions. Therefore, there would be no baseline CLV for the firm. As with the previous case, the second term in the equation corresponds to the predicted net present value of future purchases by the customer at a particular time period. Then, the third term corresponds to the additional marketing costs incurred to sell more product(s)/service(s) to the customer. The final value of these three components would yield the CLV in a non-contractual setting.
Now let us now consider a numerical example in a contractual setting to see how CLV is computed. Consider the case of Amy, a customer of a mobile phone company. The monthly subscription or the Base GC provided by Amy is $40. Standing at the end of May, the company wants to know the value Amy is likely to provide to the company in the next four months (June, July, August, and September). Table 8.1 provides Amy's probability of buying additional services or 
(such as downloads, ringtones, text messaging, etc.) for the next four months, her monthly purchase amount, the percentage of margin for each purchase, and the marketing cost incurred by the company in contacting Amy.
Table 8.1 Transaction details of Amy.
Assuming an annual discount rate (r) of 12% (or 1% monthly rate), we can now compute the CLV of Amy for the next four months. First, let us compute the CLV of Amy at the end of July using Equation 8.1.
Therefore, CLVAmy, June = $36.9.
Similarly, we can compute the value Amy would give to the company at the end of each subsequent month as follows: July, $33.2; August, $32.8; and September, $29.6. A summation of all the four months' CLVs would yield a value of $132.5. In other words, over the next four months Amy would provide $132.5 in value to the company through her subscription and additional purchases.
Table 8.1 can also be used to explain the case of non-contractual purchases. Assume that the table indicates Amy's monthly purchases from her nearby café. In this case, 
would denote the probability of Amy buying products from the café. However, this case will not have the monthly subscription or baseline CLV. Now, let us compute the CLV of Amy at the end of July using Equation 8.1:
Therefore, CLVAmy, June =− $2.7.
In other words, Amy will be costing the café $2.7 in June by receiving communications from the café and by being a part of its customer base. Similarly, we can compute the value Amy would give to the café at the end of each subsequent month as follows: July, −$6.0; August, −$6.0; and September, −$9.0. A summation of all the four months' CLVs would yield a value of −$23.7. That is, over the next four months Amy would cost the café $23.7 in value by being its customer. In other words, the amount spent by the café on marketing to Amy will be more than the profit before marketing costs contributed by her to the café.
The above illustration is a simplistic scenario for computing CLV. Given the changes and challenges in data availability and business needs, several other approaches to model and compute CLV have been developed. The two case studies that will be presented in the following section highlight the following important CLV maximization strategies:
- Efficient customer selection by targeting customers with high profit potential.
- Managing existing sets of customers and rewarding them based on their profit potential.
- Investing in high-profit customers to prevent attrition and ensure future profitability.