Calculating Customer Lifetime Value for the Travel Industry

Roomstorm
Roomstorm
Mar 20, 2016 · 7 min read

Introduction

Strong businesses are built on a solid understanding of customer lifetime value. The value of a customer who pays for a good or a service is more than that single transaction — it’s an opportunity to begin a long-lasting, prosperous relationship.

In today’s competitive market, often the first flight or room that a customer purchases barely covers the costs of acquiring him or her in the first place, therefore solid businesses should build long-lasting customer relationships. That is, whenever someone is seeking to book a hotel room or a plane flight, they look towards you for that reliable, positive experience.

According to the White House Office of Consumer Affairs, on average, loyal customers are worth up to 10 times as much as their first purchase. To understand exactly how much your loyal customers will spend over time, you can calculate your Customer Lifetime Value (CLV) based on a few simple metrics.

Having a solid understanding of your CLV helps you justify dedicating resources to customer experience and implement programs to increase customer retention.

Simply put, your CLV is the metric that tells you how much a customer is worth to you — and it’s probably higher than you think. It’s the measure of all of the expected profits you hope to gain over the length of the customer relationship. In this article, we’ll discuss how to calculate Customer Lifetime Value for the travel industry using three basic metrics. We will also cover segmentation, and how to differentiate different customer segments such as the business and leisure travelers. Then we will go beyond CLV, and discuss the hidden way each individual has a powerful impact on your business — their sphere of influence.

Calculating CLV (The Basics)

Customer Lifetime Value (CLV) is simple to estimate, and once calculated, should inform your business decisions. It will help you decide how much of your resources you should dedicate to marketing, sales, and customer success and support. At the end of this piece, you’ll have a strong understanding of Customer Lifetime Value and the ability to calculate future customer revenue based off past data, or estimate CLV for new ventures.

To begin calculating your CLV, you’ll need to understand or estimate the following metrics.

  • Average Spend
  • Repeat Sales
  • Average Retention Time

You can also add Gross Margin to your calculation, which we will discuss in the end.

Average Spend

The average spend, also known as the average order value is simply how much, on average, a customer spends at one time. For example, at a neighborhood cafe, many people come in for a coffee, and some may stay through lunch and dinner, but the average order can be calculated around $18 per person.

Average spend, however, can be a bit misleading on its own. If your average customer that comes for coffee spends $5, while the lunch meeting spends $30 per person, is it helpful to think of the average order value as $18?

It’s often more useful to segment those customers and treat their average spend differently.

Segmentation is particularly important in the travel industry. For example, for airlines, domestic versus international travel is critical. According to the US Department of Transportation, the “average” domestic trip cost $378 in 2014. An international trip can be closer to $1000.

Number of Repeat Sales

Once you’ve calculated how much a customer spends at one time, on average, you’ll need to figure out repeat sales. This is simply how frequently a customer makes a purchase again, in the same year, on average. If your customers usually make a purchase three times per year, your repeat sales number is 3. If your customers only makes a purchase every two years, repeat sales number is (½) or 0.5.

Just like with average spend, you’ll have to think about your customer segments for repeat sales to be a meaningful metric. For example, if you are a hotel in Chicago, you may find that your business travelers tend to book ten times a year, on average, but a leisure travel books once every three years.

For context, The Global Business Travel Association found that business travelers tend to book 12.86 trips per year.

Average Retention Time

This third metric is essentially the “lifetime” in “customer lifetime value”. Retention time is, on average, how long you can expect a customer to stick around for. If you’re a long standing business, this information can be extracted from historical data. A new business may have to make some projections based on a few years of information, or from industry standards.

If you’re an established business, you simply do an analysis on a few cohorts of customers from 20–40 years ago, and then average them out. (You can also see if your retention is increasing or decreasing over time this way!).

If you’re a new business, you’re forced to make an educated guess. For instance, if you want to estimate the retention rate for a business traveler, you could take into account that US workers have an average job tenure of 4.6 years: but that may be significantly higher for a corporate executive.

The Calculation

To get the customer lifetime value for each of your segments, you’re going to multiply Average Order Value, Number of Repeat Sales and Average Retention Time.

(Average Order Value) × (Number of Repeat Sales) × (Average Retention Time) = (Customer Lifetime Value).

It’s common to also include Gross Margin as part of your calculation. Gross Margin is the measure of total revenue, minus the cost of goods sold, as expressed as a percentage.

If you choose to include Gross Margin, you can add that into the equation so:

(Average Order Value) × (Number of Repeat Sales) × (Average Retention Time) × (Gross Margin) = (Customer Lifetime Value).

Let’s see how this formula plays out for a hypothetical Amazing Airline, whose customers usually pay about $500 for a flight, taking 3 trips a year on average and sticking around for 10 years. Amazing Airline’s gross margin is 5%.

Therefore, Amazing Airline CLV is $500 × 3 × 10 × 5% = $750.

CLV Calculator

We’ve created a simple online CLV calculator that you can use to determine not only CLV, but the total cost of losing a customer, including the social impact.

Measuring Social Impact and Social Influence

The value of a customer extends beyond the revenue they bring to your business themselves. Each of your customers will speak to others about the experience they had with you, and recommend (or warn) others about your business. Mathematically, each customer has a certain number that represents their referral potential, that’s based on the size of their social influence.

In today’s hyper-connected world, social influence is higher than ever. Where there once was a time an angry customer could reach a handful of their friends, now many people can put up a complaint on Facebook or Twitter and reach thousands or millions.

If a customer leaves a positive review that encourages additional customers, their referral potential will be profound and positive. However, if that same customer shares a negative review that scares away potential customers, that person is in effect subtracting future revenue from your business.

According to the White House Office of Consumer Affairs, a dissatisfied customer will tell between 9–15 people about their experience. Around 13% of dissatisfied customers tell more than 20 people.

According to IATA, airline reputation is the most important factor for choosing an airline for about 7% of all passengers. So, if your dissatisfied customer tells 15 people about their bad experience (why else would they leave your brand?), at least 1 person on average will take it into account and choose a different brand.

Conclusion

We’ve discussed the components that make up Customer Lifetime Value, and how to put them together into a meaningful metric. Using your CLV to inform your decisions will help your company realize the impact of each customers, and offer superior service to gain an edge on the competition.

Engaging loyal customers is an easier target for a business than to constantly keep acquiring new prospects. It’s 6–7 times more expensive to acquire a new customer than it is to keep a current one. According to Marketing Metrics, the probability of selling to an existing customer is a whopping 60–70%, while the probability of selling to a new prospect can be as low as 5%.

An awareness of your customers’ value will help you place additional emphasis on tools that impact customer experience, and dedicate resources to improve retention. Given all of the billions of dollars that are dedicated to acquire new customers in the travel industry, any business that wants to sustain itself must constantly seek to maximize customer lifetime value and retain their customers.

Armed with this information, you’ll be able to implement policies that ensure your customers stick around, and have a positive social influence. Your success in the travel industry hinges on realizing as much as of your CLV as possible for every traveler.


At Roomstorm, our goal is to help airlines, hotels and other businesses to retain their customers by helping them providing the best customer experience, even in an emergency, like delayed or cancelled flight, or hotel overbooking.

This article was written by Simona Asinovski, Roomstorm’s market research analyst.

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