Introduction to Customer Lifetime Value (CLV) in hotels

17 May 2022
Hotels have for several years been searching for a better KPI than RevPAR, which has been used in hotels since hotels started to practice the revenue management discipline in the late 1980ties. TrevPAR, GOPPAR, COPE, and CLV are some of the acronyms of new KPIs that hotels discuss.
The first three KPIs are transactional and capacity-driven, just like RevPAR, while CLV is customer-driven. With the revenue management discipline, hotels have become more transactional and moved away from being a customer-focused business. Maybe the KPI Customer Lifetime Value (CLV) could make hotels more customer-focused and increase profits and long-term success. This article introduces Customer Lifetime Value with links to more in-depth information and practical advice on how to get started measuring CLV.

Definition of Customer Lifetime Value

The definition of CLV is simple: Customer Lifetime Value represents a customer’s value to a company over time. The value is defined as the profit that a customer contributes to the company. The formula is straightforward: Average annual customer profit x average duration of customer retention. The value of a customer is the net profit the customer contributes to the business over time, so the value is the net profit in the future discounted to its present value. CLV is also helpful in determining the upper limit on spending to acquire a customer. A company cannot spend more on acquiring the customer than the CLV.
 
It is essential to define what a customer is to understand the use of customer lifetime value in hotels. The reason is that the definition of a customer and a guest often overlaps and is not distinct enough. A customer is an individual or business that purchases a hotel's products and services. Most hotels have two types of customers. One is Business to Consumer (B2C) which means that the guest (consumer) pays for products and services. Another is Business to Business (B2B), which means that a business pays for products and services.

Repeat sales in hotels

The two customer types behave very differently. A B2B customer, such as a corporate contract, produces many recurring stays during a year, while most B2C customer stays once in a lifetime. The exception is a few B2C customers returning once a year for a beach or ski holiday or a bi-annual visit from a small town to a large city. Mega-chains boast that around 50 % of guests staying in one of their hotels belong to their loyalty program, so half of the guests are repeat customers of the mega-chain. However, the guests are a mix of B2C and B2B customers, so the returning B2C customers to a specific hotel is very low.

Customer Acquisition Costs in hotels

Travel reasons to the destination are the primary driver of demand for overnight accommodation. Hotels rarely actively attract travelers to a destination but often passively contribute to funding destination marketing companies. Hotels have to spend money on capturing customers in the incoming flow of travelers in competition with other hotels. According to Kalibri Labs, hotels pay 15 % and 25 % of total sales on acquiring customers. The bulk of the Customer Acquisition Cost (CAC) is variable, such as commissions to OTAs and Travel Agents and transaction fees.
 
In general, theory shows that keeping a customer is less costly than acquiring a new customer. The CAC is the same in hotels if the guest continues to use the same booking channel, such as an OTA. Hotels dream of acquiring guests through OTAs and then convincing them to book direct for their next stay, but this rarely works because guests are happy with the perks they receive through their preferred OTA. If hotels had successfully converted guests to book direct, the OTAs would have had a much lower overall market share.
 
One reason CLV is thriving as a KPI in other industries is the use in SaaS companies and e-commerce, where CAC often is above 100 % of the profit of the first purchase. However, it is highly unlikely that CAC for the first stay is above 100 % of the profit in hotels. Therefore, hotels will still make money even if they only have one-time guests and no returning guests.
 
The exception in hotels is the B2B contracts, where a salesperson spends time acquiring the contract, which incurs a cost that the hotel cannot recoup until the contract has produced several room nights.

Is CLV a useful KPI in hotels?

The short answer is no since hotel customers typically generate a profit during the first (and maybe only) stay. Hotels should instead focus on understanding the Customer Acquisition Cost for different segments of customers and take actions that will decrease the CAC. There are, however, many benefits to understanding the concept of CLV. Hotels would get a better understanding of which customer segments are the most profitable, profitability per customer depending on what products and services they buy, and as a result, focus more on how to attract high spending guests and sell more to each customer. The demand from high spenders leads to improved products and services, which will attract more of the same type of customers and increase long-term profitability. For hotels that want to get more insights about CLV, read more about theory and practical advice in the following articles.