The following is an excerpt from the IAB Europe report — Digital Transformation Playbook 2019, which you can find at the link:

IAB Europe Digital Transformation Playbook 2019

What is Water?

Before transitioning your business to the digital world, you need to define what this world is. David Foster Wallace hit the nail on the head, illustrating this through an anecdote about water and a goldfish:

Understanding what this enigmatic „digital” actually is becomes crucial for your decision-making. Grasping the environment in which you operate allows you to make informed choices.

One of the primary advantages a digitally mature business holds over a traditional one is its precise measurability. You can measure, analyze, and calculate almost anything that comes to mind—as long as it has a business justification and allows for the optimization of various aspects of operations.

To conduct detailed analysis, you need specific variables. To determine business value, you should utilize more diverse indicators that enable strategic decision-making. Over time, it is essential to verify their effectiveness, meaning tracking changes in the indicators over time.

What indicators do we use to measure business efficiency?

To measure the performance of an enterprise, you would use indicators such as EBITDA, EAT, ROI (applied in a multi-faceted manner), and in relation to the customer, you could use CLTV (Customer Lifetime Value), also referred to as CLV or LTV. This represents the financial value a customer brings to your business over the entire duration of their relationship with your brand.

Digital transformation significantly alters how you build relationships with your customers (acquisition, retention, communication methods). Almost always, it is carried out by new individuals—newly hired specialists, managers, or external parties (consultants, agencies, etc.).

CLTV is one of those metrics which, when calculated correctly, allows you to avoid asking „What is water?” Moreover, when measured regularly, it helps answer the question, „What is the state of the water today?”

This not only enables a successful transition into the digital space but also continuously optimizes your business in this new reality.

This is the Water The basic formula for CLTV (for any business) is:

CLTV = average purchase value x purchase frequency x length of customer relationship – customer acquisition cost (CAC) – customer retention cost

CAC = cost of sales / number of customers CLTV is often paired with CAC, as both indicators together create an almost complete picture of sales potential. They help determine the necessary investments in building customer relationships and the return they will bring.

Things start to get a bit more complicated when you account for factors specific to your business, rather than generalized values.

For example:

• Discounts tied to the length of the relationship with the user (e.g., discounts for contract renewal).
• Significant variations in revenue and costs associated with customer relationships, depending on the business profile. A good example is airlines, where selling economy class seats is an entirely different process than selling business class seats.

In such cases, it is more convenient to segment customers and calculate CLTV for each segment individually, taking into account its percentage share of the overall business. A common-sense approach to segmentation is crucial to avoid excessive fragmentation and spending too much time calculating for each group. Balance between time and data detail is key.

In more complex revenue models, there may be specific, individual methods for calculating CLTV, where a general approach may not be precise enough.

For example:

• A company with a small number of profitable relationships (e.g., one using a freemium software model) must factor in the costs of those users who did not convert and make a purchase.
• When customers pay in ways other than money (e.g., with their time or personal data—think Facebook, Google, etc.), an additional conversion metric is needed to determine the monetized value for the business.
• In subscription models (Netflix, Spotify, SaaS platforms), the formula could be CLTV = ARPA x gross margin / 1 – churn rate, where ARPA (Average Revenue Per Account) is the average revenue per user, and the churn rate is the average percentage of users who canceled the service before the subscription ended.

What is the State of the Water Today? A well-prepared CLTV calculation model significantly aids in making assumptions necessary not only for digital migration but also in the continuous optimization process to remain effective within it. By adjusting the variables in the equation, you’ll quickly discover opportunities to increase your business’s profitability. After that, it’s simply a matter of implementing the insights from the analysis and verifying the results—following the principle of „test, learn, improve, and scale when successful.”

A well-executed CLTV calculation will help you:

• Limit costs and media losses.
• Increase the financial effectiveness of advertising campaigns.
• Group customers based on their sales value over time.
• Allocate resources to up-selling and cross-selling activities.

When calculating CLTV, you might find that your product in its current form may not be competitive enough to succeed in the digital world. This is good news because it means you can start making changes even before the digital migration begins.

Authors of the post: Piotr Rocławski, CEO, and Łukasz Heine, CRO at Yetiz Interactive.