Customer Lifetime Value: A Vital Marketing/Financial Concept For Businesses

Abstract

One of the most important decisions in finance is the investment decision. The investment decision involves the allocation of capital for investment proposals whose benefits are projected to be realized in the future. Investment decisions should be evaluated in terms of their expected risk and return. “The investment decision, then, determines the total amount of assets held by the firm, the composition of these assets, and the business-risk complexion of the firm as perceived by suppliers of capital” (Van Horne, 2002).

Customers have been identified by retailers as one of five critical assets that need to be managed effectively in order to achieve their financial objectives. Every customer varies in their lifetime value to a particular organization. The focus of companies has shifted from treating customers as just an entity involved in the business process to treating them as a critical part of their business success. In particular, the importance of a customer is judged by the longevity of a series of potential or actual transactions as opposed to his or her single transaction with the firm. Because of this, activities of a company are now targeted toward developing a long-term relationship with a customer.

This paper will focus on the need for retail businesses to establish a collaborative marketing/financial function in the recognition and management of their customer base as a separate, identifiable asset. Financial concepts such as the time value of money and return on investment have been applied mainly to fixed assets such as buildings, fixtures, equipment, land, etc. and have not been utilized toward the valuation of customers. Marketing concepts such as customer profitability and retention have focused on revenues generated from customers and have ignored financial functions such as the time value of money. Companies that create maximum value for their customers will survive and thrive in today’s marketplace and achieve a sustainable competitive advantage.

All customers are not equally important to businesses. Companies can increase their profitability by identifying and building relationships with their better customers. Marketers know that a relatively small number of customers account for the majority of their profits. This principle, called the 80-20 rule, states that 80 percent of the sales or profits for a business are generated from 20 percent of the customer base. Marketers need to segment and rank their customer base in terms of importance and develop marketing programs aimed at their highly valued customers. Only through the use of financial concepts such as the time value of money and investment principles can a marketer accurately access the importance of individual customers.