The Customer Lifetime Value Formula is Flawed

  1. It’s a summation rather than an integral. This makes the math easier, but it implicitly assumes contractual transactions with discrete purchase opportunities. However, most retail environments are non-contractual and continuous in nature. I can shop at Target any time I’d like, several times a day or not at all: non-contractual and continuous.
  2. The range from t=0 to T represents a finite customer lifetime. Customers do not all have the same lifetime, which should be accounted for somehow, but for a true lifetime value, an infinite time horizon should be used. Oh, the math is starting to make my head hurt!
  3. rt is the retention rate. However, it represents a highly unrealistic survival curve. In fact, in reality, r itself is often a function of t. As the multiplier in this summation formula, that can make a huge difference in the resulting value. The orange line below represents what is typically observed with survival curves; a steep initial drop, followed by a leveling off. The gray line below is what rt would represent instead:
Citation: Fader, Peter S., Bruce G.S. Hardie. “How to Project Customer Retention.” Journal of Interactive Marketing 21.1 (2007): 76–90. Print.

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Product Exec with a Code Habit, Founder

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Michael Scully

Michael Scully

Product Exec with a Code Habit, Founder

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