Understanding your customer lifetime value is key to understanding your business needs. The more you know about it, the better you'll be able to plan for growth.
As early as possible in your business, define and measure this value.
CLV, sometimes referred to as lifetime value (LTV), is the total amount a customer would spend with your business in one year if they continued buying from you.
What is Customer Lifetime Value (CLV)?
The total value a customer brings to a business over the course of their relationship is known as customer lifetime value.
This value is not to be confused with Net Promoter Score (NPS) or CSAT, which measure customer loyalty and satisfaction, respectively.
Debates around CLV often center on the Pareto Principle: 20% of your customers account for 80% of your sales.
Since CLV measures the financial value of customers, it can help businesses allocate resources.
For example, how much to invest in acquiring new customers and how much to spend on retaining current customers.
CLV is a combination of a customer's probability of spending money with a company and the average amount of money that person is likely to spend with the company over their lifetime.
There are two ways to look at CLV: the historic method and the predictive method. The landmark method uses past data to assess a customer's value.
The predictive method goes one step further – it tries to predict the future value of a customer's purchases.
There are various models, based on multiple formulae, to calculate CLV. If you want to get into those details, read our posts on how to calculate CLV.
While on the face of it, calculating CLV seems very simple:
CLV = customer value X customer lifespan, or
CLV = lifetime value X profit margin. But it is not so.
Never forget that all your customers are not the same, so you need to calculate CLV by customer segment. Also, to start the exercise, you need the following on hand:
Average purchase value, average purchase frequency, and average customer lifespan.
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5 Ways Customer Lifetime Value (CLV) Helps Businesses
Simply put, customer lifetime value is essential to businesses because it helps them estimate the profit they can expect from a customer over the course of their relationship with the company.
1. CLV is determined by calculating the total value of all the purchases a customer makes, minus the cost of acquiring that customer. (In other words, CLV is determined by the future value of a customer's lifetime of purchases, not just a single purchase.)
2. Businesses also use CLV to measure the financial return on investment in acquiring and retaining customers.
When a company invests in acquiring new customers and maintaining relationships, it's crucial to invest in the right business strategies.
Metrics such as CLV play a significant role in helping the company understand the "actual value "of a customer, so it can invest and allocate resources appropriately.
3. CLV is used to help businesses determine how much they should invest in acquiring and retaining customers.
It's a valuable metric for businesses because it helps them understand the long-term value of a customer.
It takes into account not only past purchases but also future potential purchases.
For example, if a customer spends more than $1,000 with a business over twelve months, it is safe to assume that they will spend at least the same amount with that business over the next year.
4. CLV is also often used as an internal measure for comparing the performances of different companies or evaluating if one investment strategy is better than another.
It is also a helpful measure for comparing and assessing the performance of different businesses within the same company or between two different types of businesses.
For example, we are all aware that B2C and B2B businesses differ: sometimes B2C companies rely on monthly subscriptions, while B2B businesses are more likely to have contracts lasting a year or more.
CLV is then helpful in measuring the success of B2B businesses that invest heavily in acquiring customers by offering large contracts over long periods.
5. Some of the other reasons why CLV is essential are that it helps you boost customer loyalty and helps your marketing target your ideal customers.
What's involved in Calculating Customer Lifetime Value (CLV)?
To reiterate, calculating CLV is not as simple as it seems.
For example, if Mrs. Smith has been buying $100 worth of shoes from the same eCommerce company for over 10 years, her CLV will be $ 1,000, right? Yet things get complicated when Mrs. Smith also buys socks & bunion correctors along with her shoes.
More than 1 item in the purchasing cart complicates things. The larger a company is, the larger its customer base, and the more regularly a customer buys over a period, the more complicated the calculation of CLV becomes.
As we said earlier in this post, there are different ways to calculate CLV. Before that, here's the data you need to have with you:
- You need to know the average amount a customer spends with your company over their relationship with your company.
- You also need to know how long customers typically stay with your company.
Once you have those figures, you can divide the total amount a customer has spent by the number of years they have been a customer to get the average customer lifetime value.
The average CLV is almost always greater than your initial investment in a customer, but it can vary widely from customer to customer.
Another critical factor in calculating CLV is determining whether the customer has a long-term or short-term relationship with the brand.
One of the biggest challenges in calculating CLV is that it can be hard to know exactly how long customers have been with your company, because many companies do not track this data.
If you are one of those who do, that's great.
But here's a way to still get a sense of your customers' value: use customer engagement data.
This data is defined as customer interactions with the brand, not just the purchase. You can find this by assigning a retention score to each customer, which is the number of users who are still active within a given time frame.
With this, you then calculate the Average Interaction per User (AIPU). This is calculated by multiplying the user's average number of interactions with the brand (usually between 1 and 10) by their retention score. By doing this, we create a predictive number for a user's sort.
Steps to Measure Customer Lifetime Value (CLV)
Customer lifetime value is a metric that measures the financial value of a customer over the duration of their relationship with a company.
To calculate CLV, you need to know three things: how much a customer spends on average each year, how long they remain a customer, and the company's profit margin.
Once you have those figures, you can use this formula:
CLV = (Avg. Annual Spend x Avg. Time Spent as Customer [retention]) / (Profit Margin / Revenue)
Average Annual Spend is based on the average revenue per customer. Although revenue comes from the bottom line, a company does not see revenue from some customers in the early years.
Instead, this figure is based on the average spending of all customers over a period.
Average Time to Stay as a Customer (ATS) is the average time a customer stays with the company. You can assume the average customer stays with a company for about 2 years, so use that as your estimate.
Total Annual Spend (TAS) is the sum of customers' annual spending. Some customers may have very small or huge budgets, so you need to calculate each customer's spending individually.
The Average Annual Spend (AAS) is the total annual spend divided by the number of customers. The AAS tells you how much the owner is spending on their business on a monthly or yearly basis.
The customer's lifetime value is calculated as the value of their entire basket of products purchased over the past 12 months (or any number of months for high-value customers).
While doing this, the value of a customer's basket is calculated by multiplying the prices of each product in the customer's basket by the fraction of total purchases made from that merchant.
For example, if a customer purchases $1,000 worth of goods from your company, then the value of that customer is calculated by multiplying the price of each item in the purchase by its fractional usage.
When these values are calculated, they can be summed to form a single number representing the customer's total value.
Make smarter investments by understanding what your customers are really worth. Get started with CLV analytics >>> Talk to our analytics experts
How to Improve Customer Lifetime Value (CLV)?
Measuring customer lifetime value is extremely important in any business, as it enables companies to evaluate the performance of marketing campaigns and determine how much revenue to invest in a particular campaign.
As mentioned in this article, you can use any number of models to measure your customers' TV. Which one is better for you will depend on the size of your product and the amount of data you can collect about your customers.
You might say that the best way to increase CLV is to decrease the cost of acquiring a new customer. But that's really true.
The other way to increase CLV is to continue to retain customers and give them more value. The best way to do that is to create innovation.
It says that companies not only can and must be very customer-focused but also should be highly innovative to compete successfully in the future.
This requires that business leaders keep in mind the likely patterns of change in the world and adapt to them.
What you can do to improve Customer Lifetime Value (CLV)
- Reduce customer churn
- Introduce a customer loyalty program
- Improve customer onboarding
- Improve customer experience
- Re-target or re-engage previous customers
Businesses can maximize customer loyalty, retention, and lifetime value by leveraging Express Analytics' predictive customer modeling and advanced multi-channel campaign automation services.
Our customer data platform, Oyster, helps your business acquire more customers, increase spending by existing customers, and reduce customer churn.
Conclusion: The sooner your business starts calculating and measuring your CLV, the better. CLV, or customer lifetime value, is a measure of how much a customer spends with you in a year if they continue buying from you.
