CALCULATING CUSTOMER LIFETIME VALUE

Researchers and practitioners have used many different approaches for modeling and estimating CLV.
Columbias Don Lehmann and Harvards Sunil Gupta recommend the following formula to estimate the CLV for a notyet acquired customer:

A key decision is what time horizon to use for estimating CLV. Typically, three to five years is reasonable. With
this information and estimates of other variables, we can calculate CLV using spreadsheet analysis.
Gupta and Lehmann illustrate their approach by calculating the CLV of 100 customers over a 10-year period
(see Table 5.3). In this example, the firm acquires 100 customers with an acquisition cost per customer of $40.
Therefore, in year 0, it spends $4,000. Some of these customers defect each year. The present value of the profits
from this cohort of customers over 10 years is $13,286.52. The net CLV (after deducting acquisition costs) is
$9,286.52, or $92.87 per customer. Using an infinite time horizon avoids having to select an arbitrary time horizon for
calculating CLV. In the case of an infinite time horizon, if margins (price minus cost) and retention rates stay constant
over time, the future CLV of an existing customer simplifies to the following:

In other words, CLV simply becomes margin (m) times a margin multiple [r/(1 + i r )]. Table 5.4 shows the
margin multiple for various combinations of r and i and a simple way to estimate CLV of a customer. When retention
rate is 80 percent and discount rate is 12 percent, the margin multiple is about two and a half. Therefore, the future
CLV of an existing customer in this scenario is simply his or her annual margin multiplied by 2.5.