What’s wrong with the CLV formula?
It is common for analysts to learn a formula to calculate CLV that is a generalization of the following:
CLV = ∑ t=0 T m r t _ (1 + d) t
where m is the net cash flow per period, r is the retention rate, d is the discount rate, and T is the number of periods or time horizon.
But what are the pitfalls of this formula? Let’s explore them next.
Issue 1
The actual CLV of a client only becomes evident once they cease to be a customer. Thus, any CLV calculation can only serve as an approximation of a customer’s true worth.
Issue 2
Setting the summation’s upper bound as T might not be ideal unless we intend to conclude our association with the client at that projected future date. Such an approach wouldn’t fully capture a customer’s projected CLV, as it neglects potential value beyond T. This limited perspective could be termed “truncated...
