The Focal Point Blog // Business Strategy // Dave Annis // March 18, 2021

4 Questions Customer Lifetime Value can Help Your Digital Services Company Answer

Customer lifetime value (CLV) is a popular metric used at SaaS and product companies, but we don’t see it measured as frequently at professional service organizations.

We’re big proponents of using CLV as a digital agency KPI because it helps leaders make proactive strategic decisions that can ultimately support digital services growth (and increase the average CLV).

Customer lifetime value (CLV) calculates the total profit margin you can expect to earn from a customer throughout their entire lifecycle with your business. Each company’s average CLV will vary based on average customer lifespan, the services they offer, and how well they retain and upsell existing clients. But there are several ways every digital services company can use CLV to improve business operations and performance.

How to use CLV at your digital services company

Google “how to calculate CLV,” and you’ll find numerous formulas. One simple way to calculate customer lifetime value is using this formula:

CLV = Average Revenue Per Customer (Annual) × Average Customer Lifespan x Gross Profit Margin

To get even more precise, your business can account for a variety of other factors that impact your CLV, including how likely each customer is to expand their engagement with you. First Page SEO shares a few factors to consider adding to your CLV calculation, including: 1) Likelihood (and value) of service expansion, 2) Likelihood of new customer referral, and 3) Likelihood of reference or case study.

Regardless of which formula you use to calculate CLV, it is critical to use one that accounts for costs, so you calculate profit and not just revenue. Accounting for costs is important because different factors (e.g., the combination of resources you assign to a project) can affect project costs and, in turn, how profitable it is. The accounts and projects that generate the most revenue are not always the most profitable.

In a similar vein, profitability alone doesn’t identify your best customers. Some highly profitable customers could actually be your worst customers if they’re toxic or misaligned with the agency’s vision or culture. Profitability isn’t the only data point to identify your best customers, but it is an important one.

We want to help digital agencies see CLV for all that it is and all that it can help you understand about your business. Here are four questions that customer lifetime value can help you answer to uncover important agency insights that inform strategic decisions.

1. What types of customers are most profitable?

Not all customers are equal, so not all customers will have the same CLV. Go beyond simply calculating an average customer lifetime value across your portfolio and calculate CLV for each customer. Then, bucket customers into groups based on account similarities (e.g., company size, industry, the job title of executive sponsor) to get an average. Calculating the average CLV of each customer type can help you identify patterns in your most profitable customers. For example, “our CLV is highest when an IT director at a consumer technology company with 500-1,000 employees hires us to solve a technology challenge.” These patterns can help you tailor your sales and marketing efforts to target prospects and buyer personas similar to your most profitable customers.

To bucket customers and identify patterns, you need visibility into up-to-date CRM data. If you’ve developed sales operations best practices that keep this data fresh, you can cross-check customers against things like the source of lead, company size, decision-maker, NPS score, primary business challenge, and more. You can get as granular or high-level as your business needs.

Reminder: The customers that bring in the most revenue are not always your most profitable customers. High-revenue customers could also have the highest costs that eat into your profitability. Or, depending on where the customer is in their lifecycle, their profit margin could be on the decline. These are all insights that CLV can help you uncover.

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2. What types of projects are most profitable?

Uncovering patterns between your customers with the highest CLV is the first step to identify your “best” customers. The next is to dig a little deeper to understand how various projects affect the customer lifetime value. If you have a different CLV between two similar customers, explore why that could be. Factors that could affect this include:

  • Project type: What kind of service are you providing, and which is most profitable? For example, is it a wedge offering, mobile app development, user experience design, or paid media campaign?
  • Pricing structure: Are you charging based on the project, a retainer, or time and materials? Which seems to be most profitable for your agency
  • Team makeup: Do you have your best (and most expensive) talent assigned to certain projects but have more junior employees managing others? How is resource allocation affecting profitability?

Digging into the data can help you determine what drives profitability within projects. It can also help you spot which projects are growing and becoming more valuable to customers (or declining and becoming less valuable). Use this information to improve CLV across accounts by upselling your most profitable projects to customers that haven’t bought them but could benefit from them.

3. When does profit margin typically start to decline?

Chart customer lifetime value over time to pinpoint when margin typically starts to decline. If your average customer lifespan is three years, but margin starts to fall at two years, you can brainstorm ways to improve profitability at this stage. This may be the right time in the lifecycle to introduce your customers to higher-value services, like the ones you identified as your most profitable projects. You might also realize you have a gap in your service offerings and need to invest in innovation to develop offerings that support customer needs for longer (and increase your CLV).

4. Which customers can we leverage for innovation?

Customer lifetime value also helps you pinpoint which accounts have profit wiggle room to test innovative ideas. Let’s say you have a highly profitable customer that isn’t nearing the point in its lifecycle when profitability declines. You can offer this customer a new service that may not be profitable (yet) but that your team thinks could be a service offering with a lot of growth potential in the future. This customer provides you with a cushioned testing ground to vet the idea and build processes and methods. The profitability of this account gives you the flexibility to take innovative risks that provide important business insights.

This innovative work is what McKinsey’s 3 Horizons of Growth advocates for in Horizon 2. If you only focus on your most profitable work (Horizon 1), you don’t invest the time necessary into predicting what customers will want from you next. Agencies risk all of their services becoming commoditized if they don’t consistently wear their “innovation hat.”

Get visibility into data that informs CLV

To calculate and keep your customer lifetime metric up to date across accounts, you need real-time access into the data that informs it. It should be easy for your team to quickly identify the revenue and profitability of each customer and the profitability of each service area. These insights help you determine proactively if a customer or service is becoming more or less profitable, which supports proactive strategic action.

Parallax provides consistent, reliable, and real-time data governance from sales to delivery and beyond. Our product makes it easy to get the data you need, and segment reports by project type, customer, or skill set. Parallax’s forecasts give you a view into the future to predict where things are headed with customers, so you can make data-informed adjustments before it’s too late.