In the October 2007 issue of Harvard Business Review, an article titled How Valuable Is Word Of Mouth discusses the distinction between customers’ lifetime value and referral value. The article say this about CLV:
Estimating a CLV is relatively straightforward. The value to FirmCo of all that Mary will ever buy equals the amount that her purchases will contribute to FirmCo’s operating margin minus the costs of marketing to her.”
Oh really? And what should we do with the costs of providing service to Mary during her tenure as a customer? Ignore them? Assume they’re equal across customers?
The article goes on to say:
No one really knows how much Mary will buy from FirmCo in the future, but we can make an estimate by analyzing her past purchases over some period of time…then projecting that pattern forward using sophisticated statistical models.”
This is a fairly common practice in many firms. This approach ignores two important factors, however:
1) Life stage events. In research I did that looked at the impact of moving on consumers’ purchase habits, I found — not surprisingly — that consumers who move make a lot of purchases in and around the time of their move. But, more interestingly, many consumers change their ongoing purchase habits — sometimes spending more, sometimes spending less — in many product/service categories, depending on the reasons for the move. Most CLV calculations, even those employing “sophisticated” models, miss these events.
2) Moments of truth. A term coined by McKinsey, these customer interactions leave an indelible mark on the relationship. If positive, they can amplify the relationship — if negative, they could kill it altogether. I’m not aware of any firm that explicitly incorporates the possibility or likelihood of these “relationship disrupters” in their CLV calculations.
The HBR article makes a case for why — and how — to incorporate referral value into a CLV calculation. But marketers should also: 1) incorporate service costs; 2) account for life stage events; and 3) model for relationship disrupters.