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Understanding the CLV Formula

Watch Raj Venkatesan explain how to manipulate the CLV formula to test its validity.
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It helps to look at the basic CLV model in two components. One is called The shuttle margin, which is the margin you get each period. In the Netflix case it would be a month. So that would be M-R. And then the CLV formula multiplies this M-R by something called a long term multiplier. Think of the long term multiplier as the expected lifetime, right. So you multiply a short term recurring margin with the number of periods it recurs. That would be the long term multiplier R, the lifetime expected lifetime of the customer. So now, we’ve got to kick the tires a little bit and see whether this formula makes sense. So how do we do that?
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Let’s think about what happens to the long term multiplier if retention rate increases. So if retention rate goes up what happens to the long term multiplier? Think about that, take a few minutes and I’ll be back. So, did you figure it out? What happens to the long term multiplier if retention rate increases? How does the discount rate change? That was a trick question. It does not change. Discount rate stays the same. What happens to the long term multiplier? Now, this we have to think about. So if retention rate is higher, this term, the denominator goes down, which means the long term multiplier goes up. So does that make intuitive sense?
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If a person is retained for longer, that is if the retention rate goes up, you would think their expected lifetime to go up, which makes sense. If their expected lifetime goes up, should their customer lifetime value go up too? Yes. The formula says it goes up and it makes intuitive sense. So this is a way to kind of look through the formula you know, see what happens to the formula if you adjust some of these variables. What happens if retention increases? What happens to the long term multiplier CLV? Does it make intuitive sense? It makes. So it seems like the formula is working.
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Now what we’re going to do after a few minutes is work through some real numbers examples on the CLV formula.

The base CLV formula has two components, which you can manipulate to test your understanding of the formula. Does it make intuitive sense to you?

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