Fixing the Customer Lifetime Value Equation

You've likely heard of the Customer Lifetime Value calculation, or CLV. Run your actual and projected costs in attracting and keeping a customer over a fixed time period and compare those expenses to the sales said customer is expected to produce. The result is a number called Net Present Value.

The question to be answered: Are your marketing costs in developing a customer greater than the amount they will purchase from you? Fire the customers with negative NPV, and invest more heavily in the real money makers.

There is just one problem with NPV, says Detlef Schoder in the December issue of Harvard Business Review. It provides a good number only at the time of calculation. You could end up cutting loose customers who, over time, will turn into profit machines. So he and his colleagues added the idea of "real options" to the CLV equation -- the option of jettisoning a customer at some point.

Their 5-step process ends with a CLV that considers what could be saved by dropping a customer at any given period. Says Schoder:

"Companies have been using real options for a long time to optimize their investment portfolios. It's time they applied them in the valuation and management of their investment in customers, too."

In hindsight, have you let go a customer and lived to regret it? Do tell.