Customer Lifetime Value: An Introduction for Restaurants

Customer lifetime value (CLV) is one of my favorite metrics.  It's also one of the more difficult metrics to properly gauge, understand, and utilize.  So let's dig in!

CLV is simply the present value of all the future profits for a customer across their lifespan with your business.

Pretend that we have a crystal ball, and can see into the future. Bob is a new customer with Joe's Pizza, and he will do the following:

  1. Place one order today for $50
  2. Place an order in two weeks for $75
  3. Place another order in four weeks for $25
  4. Bob then moves to become a monk in the Himalayas and never returns to Joe's Pizza

Bob's lifetime value, in revenue, is approximately1 $1502.

Trouble is, because a restaurant isn't like a gym, and you don't sign a 12-month contract for pizza, this requires some predictive work.  We have to accurately predict Bob's future purchasing behavior.

Why Should Restaurants Care About Customer Lifetime Value?

I like to call customer lifetime value a "second-order metric" because it can't be calculated or maximized directly; instead, it's driven by a variety of factors that a restaurant owner should seek to improve.

CLV covers many of the main drivers of a restaurant's fiscal success, wrapping them all into one number.  As an owner or manager, if you're able to increase CLV over time, you're probably heading in the right direction.  In short, CLV is a comprehensive metric that covers many other key business factors.

That said, as an owner or manager, you can't simply set out to increase CLV directly.  You have to work on improving the underlying metrics and factors.

Key Drivers

Let's think on the key components or drivers of CLV:

  • Spend/revenue per order (check size)
  • Margin (profit per order)
  • Order frequency
  • Customer retention
  • Retention cost

But what does that mean for a restaurant?  Ideally, to achieve a high CLV restaurants will need to:

  • Have a high margin on each order
  • Have customers that order often
  • Keep customers around for a long time
  • Minimize the cost to keep customers returning

What's Next?

In the coming weeks, we'll cover actionable steps to boost CLV, techniques to predict CLV, ways to apply CLV to your business, and some key limitations/considerations when working with CLV.

Footnotes

  1. We say "approximately" because of the time value of money, as the $100 in future spending is worth slightly less than today's dollars. A good CLV model will incorporate some form of discounting to bring all future sums into today's dollars, or the net present value (NPV).
  2. Note that in this case, we're looking at revenues, not profits.  CLV modeling works best when profits can be accounted for, instead of simply revenues, but in many real-world situations, profits at the item- or order-level are unavailable, so we work with revenues instead. 
  3. For further reading, we recommend Fader, Peter S., Bruce G.S. Hardie, and Ka Lok Lee (2004), "'Counting Your Customers' the Easy Way: An Alternative to the Pareto/NBD Model." Abstract | PDF | Notes
  4. For a video explanation, Peter Fader does a nice job on this YouTube video.