Physical assets, customer purchases, total revenue – all of these have value for any business. But there is one metric in particular that companies find to be of great importance and that is Customer Lifetime Value. Digital strategy expert, Adam Stewart explains what CLV is, how to calculate it, and why it matters for your business.
You may have heard of customer lifetime value (CLV) as one of the critical figures to establish in a business.
What is it, exactly? And more importantly, how can you calculate it for your own business?
In this article, we’ll go through what you need to know about customer lifetime value and how to calculate it. We’ll also share some tips and suggestions in the following sections.
What is customer lifetime value?
Customer lifetime value, also known as CLV, is the estimated profit a company will earn from a particular customer, over the entire duration of their relationship with that company.
Calculating the customer lifetime value can help businesses make better decisions about which existing customers are worth investing in, and how much they should spend to keep them happy.
All of these help businesses understand how to retain their repeat customers.
Importance of customer lifetime value
There are three great reasons to get to know your business’ CLV:
1. Reduced costs
Knowing your CLV can help businesses save more by eliminating the need to spend excessive effort and money in order to gain new clients or customers.
Acquiring new customers is proven to be more expensive than keeping existing buyers, who are more likely to purchase from you.
2. A guide for your next steps
By determining your CLV, you can effectively plan marketing activities, properly spend for customer loyalty initiatives, establish proper budgets and more.
3. Focus on customer segments that are more valuable to your business
You can better evaluate how to retain your repeat customers from each of your customer segments, if you know their customer lifetime values. Additionally, you can identify which segments are generating the most profit.
How to calculate CLV
The formula for CLV is simple, as presented below:
However, to determine your CLV, you still need to calculate the customer value and average customer lifespan.
Customer value
Beginning with customer value, you’ll need to multiply average purchase value by average purchase frequency rate.
To determine both, you’ll need to follow the steps below:
- Average purchase value = Total revenue for the year divided by the number of purchases throughout the same year.
- Average purchase frequency rate = Number of purchases in one period divided by the number of customers in the same period.
Average customer lifespan
To calculate this, you need to average the number of years your customer has been purchasing from your business.
Once you have the figures for customer value and average customer lifespan, you can now calculate your CLV.
It is worth mentioning that some companies use a different approach when calculating the customer lifetime value. Other companies use the ‘historical’ approach or the ‘predictive’ method of calculating your CLV.
Either way, we will be discussing both in the following sections to help you decide which approach is best for your business to use.
Historical CLV
If your company has been collecting simple data regarding your customers, then historical CLV might be the better option for your business.
This model takes into consideration the costs of returns, marketing, customer service, etc.
How to calculate historical CLV:
- The formula for average Gross Margin:
However, there are some pros and cons to the historical method of calculating your CLV.
Pros:
- Presents the actual profitability figures of each customer.
- Proven to be useful for businesses that have customers that are alike, when it comes to preferences and interaction with your brand in a given time period.
Cons:
- Crunching the numbers may be difficult because the calculation done is based on individual customers.
- If there are any changes when it comes to customer behaviour, CLV will be affected.
Predictive CLV
If you want an approach that’s more accurate, you may utilise the predictive CLV model. It includes not only past transactions, but also the prediction of customer behaviour of your current customers.
Below is the simplified formula for it:
- How to calculate Average Order Value:
Pros:
- Over time, data will be more accurate after every purchase from the customer.
- Prediction is based on customer behaviour and past transactions. This makes it a better option compared to the historical approach.
Cons:
- Data may be more accurate over time but will never be 100 per cent accurate.
5 business tips to keep customers coming back
1. Provide a great onboarding process
When it comes to the onboarding process, ensure that your customers are properly assisted after purchasing from you. You want to acknowledge their concerns and offer them guidance on how to best utilise your product.
Sending an e-book only to those who have purchased your product is one way to provide value and be helpful to your customers.
2. Deliver exceptional customer service
Customer service is one of the avenues where your frequent buyers can reach out to you for further assistance before and after purchasing from you.
Make sure that the value delivered for both onboarding and customer service is just as equally helpful for the customer.
Your onboarding process may be phenomenal but if customer service is not great, then it will definitely have a negative impact on your customers.
3. Increase the number of orders
Simply put, the more orders you have, the more profit you can gain for every existing customer you have.
4. Establish a loyalty program or offer rewards
You want to make your repeat customers feel appreciated, seen and heard. One of the many ways you can do that is through a loyalty program or by offering rewards for being a consistent patron of your business.
A discount voucher or providing free shipping are great options to include in your program or as a reward.
5. Provide value-adding products, solutions or services
By offering value-adding efforts in addition to a personalised experience, you increase the likelihood of your buyers purchasing from you, as well as remaining to be brand loyal. As a result, CLV increases.
Some value-adding tactics that could be implemented in your strategy:
- Offering complimentary products
- Access to exclusive offers
- Providing helpful content for your customers to consume alongside their purchases
- Sending email updates
To sum it all up, customer lifetime value is one of the most important metrics that businesses should understand. It indicates how much profit a company can generate from each individual existing customer.
There are many ways to increase CLV, such as providing a great onboarding process, having exceptional customer service, increasing the number of orders, establishing loyalty programs or offering rewards, and providing value-adding efforts.
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