Best practice report: Customer Loyalty 2

January 2, 2014 by Limited

Measure and Evaluate

The following provide some simple ideas on how the effectiveness of customer loyalty management processes might be measured and evaluated:
Lakshmi Tatikonda, emeritus professor of accounting at the University of Wisconsin in the United States, defines Customer Lifetime Value (LTV) as “the present value of profit streams over the life of customers with an organisation”. [5,6] The following is a formula and worked example for estimating customer lifetime value:

To demonstrate the value of improving customer retention rates, the LTV was calculated for an organisation with following characteristics:

  • discount rate = 12% (this is the organisation’s cost of capital)
  • customer base = 100,000
  • average length of loyalty = 5 years
  • average profit margin generated by first-year customers = $2,000
  • average profit margin generated by customers beyond the first year increases 20% each consecutive year.

In addition to this significant increase in profitability, a customer retention growth of five per cent, over a five-year period, would result in more than $20 million in additional revenue, as more than $20 million in additional revenue, as can be seen in the two tables in the opposite column (Figure 6):

The return on investment for customer retention improvement projects is significant. The full details of these calculations may be downloaded by members from the BPIR site.