How important is the customer lifetime value (CLV) for your business?
Getting to know your customer lifetime value is key to understanding and knowing what your business needs. The more you know about it, the better you’ll be able to plan for growth.
As early in your business as possible, start by defining and measuring this value.
CLV, sometimes referred to as lifetime value (LTV), can be described in one sentence as the total amount of money a customer would spend with your business in one year if they were to continue buying from you on an ongoing basis.
Table of Contents
- What Is Customer Lifetime Value?
- How Does CLV Help A Business?
- Elements Involved In Calculating Customer Lifetime Value
- How To Improve Customer Lifetime Value?
What is Customer Lifetime Value (CLV) Introduction
The total worth of a customer 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 revolve around the Pareto Principle: 20% of your customers represent 80% of your sales.
Since CLV is a metric that helps businesses measure the financial value of their customers, it can be used to help businesses make decisions about how to allocate their 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 historic method looks at past data to judge how valuable a customer is.
The predictive method goes one step ahead – it tries to predict the future value of a customer’s purchases.
Prospect new customers with lowest churn and highest LTV
There are various models based on many 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 based on customer segments. Also, to start off the exercise, you need the following on hand:
Average purchase value, average purchase frequency, and average customer lifespan.
5 Ways Customer Lifetime Value (CLV) Helps Businesses
Simply put, customer lifetime value is important to businesses because it helps them measure how much profit they can expect to make 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 the relationship, it’s important to invest in the right business strategies.
Metrics such as CLV play a big role in helping understand the “true value” of a customer so that the company can then correctly 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 he/she 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 useful measure to compare and assess the performance of different businesses within the same company or between two different types of businesses.
For example, we all are aware that B2C and B2B businesses are different: sometimes, B2C companies rely on monthly subscriptions while B2B businesses are more likely to have contracts lasting a year or more.
CLV is then useful to measure the success of B2B businesses that invest heavily in acquiring customers by making offers on large contracts over a long period of time.
5. Some of the other reasons why CLV is important is 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.
So, 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 $1000, right? Yet, things start to 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 bigger a company, the larger its customer base, and the more things that a customer buys regularly over a period, the more complicated does calculate CLV gets.
So like we said earlier in this post, there are different ways of calculating CLV. Before that, here’s some data you need to have with you:
- You need to know the average amount of money a customer spends with your company over the course of their relationship with you.
- 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 going to be more than your initial investment in a customer, but it will also differ greatly from customer to customer.
Also, another important factor while calculating CLV is to understand whether the customer has a long-term or short-term relationship with the brand.
One of the biggest challenges with calculating CLV is that it can be very difficult to know exactly how long customers have been a customer 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 an idea for calculating the worth of your customers; it’s by using 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 for each customer, which is the number of users that are still active within a certain time frame.
With this, you then calculate the Average Interaction per User (AIPU). This is calculated by multiplying how many times a user interacted with the brand (their average number of interactions, usually between 1 and 10) by their retention score. By doing this, we create a predictive number of a user’s worth.
Steps to Measure Customer Lifetime Value (CLV)
Customer lifetime value is a metric that can be used to measure the financial value of a customer over the entire duration of their relationship with a company.
In order to calculate CLV, you need to know three things: how much a customer spends on average each year, how long he/she remains 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 for some customers in the early years.
Instead, this figure is based on the average spending by all customers over a period of time.
Average Time Spent as Customer (ATA) is based on the average time a customer stays with the company. You can assume that the average customer is with a company for about two years, so you can use that.
Total Annual Spend (TAS) is the sum of the customers’ annual spending. Some customers might have very small or very large budgets, so you have to calculate each customer’s spending individually.
The Average Annual Spend (AAS) is simply the sum of 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 annual basis.
CLV of the customer is calculated by calculating the value of the customer’s 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 added together to form a single number that represents the total value of the customer.
Prospect new customers with lowest churn and highest LTV
How to Improve Customer Lifetime Value (CLV)?
Measuring customer lifetime value is extremely important in any type of business since it enables companies to evaluate the performance of marketing campaigns and determine how much revenue should be invested into a particular campaign.
As mentioned in this article, you can use any number of different models to measure your customers’ LTV. 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 not 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.
In 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.
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