Customer lifetime value (CLV) is an important aspect of modern business. It measures the long-term economic benefits that can be derived from a customer over the course of their relationship with a company.
In this comprehensive guide, we’ll answer the question of what is customer lifetime value and teach you how to develop effective marketing strategies and profitability models to increase CLV. We’ll also show you how to easily calculate customer lifetime value for your business. Ready? Let’s get started!
Key Takeaways
- Customer lifetime value (CLV) is a metric used to measure the total value of a customer to a business over their lifetime.
- Customer lifetime value helps identify high-value customers, informs how much to invest in customer acquisition, and enables businesses to improve customer loyalty.
- Calculating customer lifetime value involves multiplying average purchase value, purchase frequency rate, and average customer lifespan.
- Strategies for improving customer lifetime value include focusing on retention of existing customers, upselling/cross-selling products, personalizing marketing efforts, improving customer experience, and offering subscription services.
What Is Customer Lifetime Value?
Customer lifetime value is the total value of a customer over their lifetime. When calculating CLV, there are three approaches: historical, predictive, and traditional. By understanding your CLV, you can identify which customers are most likely to stick around long-term, allowing you to focus on acquiring new ones while improving customer loyalty and satisfaction. This helps increase customer lifetime value, resulting in more profit margins plus better relationships.
Customer Lifetime Value Models
The customer lifetime value model provides insight into the financial value of each customer over time. There are three types of CLV models: traditional, predictive, and historical, and understanding the differences between them is crucial in maximizing the value of your customer base.
Traditional Customer Lifetime Value Model
Traditional CLV models are based on historical sales data and are used to predict future customer lifetime value based on past behavior. This model takes into account demographic information, such as age, gender, income, and location, as well as purchase history and frequency. This information can then be used to calculate the expected revenue a customer will generate over their lifetime, allowing businesses to adjust their sales and marketing strategies accordingly.
Predictive Customer Lifetime Value Model
Predictive CLV models take a more data-driven approach to customer value measurement. These models analyze customer data in real-time to predict future behaviors, such as purchase frequency and product preference. Predictive models use complex algorithms and machine learning to analyze customer data, leading to more accurate predictions of customer value. This data can then be used to inform sales and marketing strategies and assist in customer retention efforts.
Historical Customer Lifetime Value Model
Historical CLV models are used to analyze the lifetime value of a customer after they have stopped making purchases with the company. This model looks at customer lifetime value over a more extended period, allowing businesses to identify trends and patterns in customer behavior over time. By understanding the historical behavior of their customers, businesses can improve their marketing and sales strategies and develop more effective customer retention efforts.
Why Is Customer Lifetime Value Important?
As a sales professional or a business owner, one of the most important things you need to understand is the value of your customers. While it may be easy to measure the value of a single purchase, knowing the value of customers over their lifetime can open doors to increased revenue and long-term business success.
Below, we delve deeper into why knowing customer lifetime value is important to your business and the benefits of calculating this metric.
Provides a Better Understanding of Customer Behavior
Knowing CLV means you better understand your customers’ behavior. By analyzing this metric, you can identify patterns in their buying habits and preferences and determine which products or services they are most interested in. This information can help you make informed decisions about future product or service offerings and transform your business into a customer-focused model.
Lets You Identify Most Valuable Customers
Another significant benefit of knowing CLV is identifying your most valuable customers. These are the individuals who are the loyal customers who are likely to purchase from you repeatedly and who generate more revenue for your business over their lifetime. By recognizing the value of these existing customers, you can focus your marketing efforts on them and build strong relationships to retain them over time.
Helps You Determine Marketing Spend
Knowing customer lifetime value can help you avoid cutting corners in marketing. Instead, you can gain greater insights into the amount of money you need to spend on marketing to acquire a new customer or to retain an existing customer. When you invest more money in customers who are expected to generate higher CLV, you’re more likely to see a return on that investment.
Lets You Forecast Revenue
Forecasting revenue is a significant challenge for any business, but knowing the lifetime value of your average customer can help you address this challenge with more confidence. By analyzing the data, you can estimate the amount of revenue you can expect based on the average CLV of your customers. These estimates will allow you to make more informed decisions about future investments or expenses.
Enables You to Prioritize Business Goals
Finally, knowing the lifetime value of your average customer will help you prioritize your business goals. For example, if you aim to increase revenue, you could focus on strategies to target high CLV customers, such as offering them personalized promotions or introducing loyalty programs. Alternatively, if your goal is to improve customer retention, you might improve your customer service methods, product offering, and more, based on your customer lifetime value data.
How to Calculate Customer Lifetime Value
Knowing how to calculate customer lifetime value is essential for any business. It helps you identify high-value customers, decide how much to invest in acquisition, and create loyal customers. But how do you get started? We’ll explain the process below for calculating traditional CLV, beginning with estimating the average purchase value.
Estimate the Average Purchase Value
How much are your customers really worth? Knowing this helps you understand how valuable they are for your business. Estimating the average purchase value (APV) is key to understanding CLV. To calculate it, you divide the total revenue generated in a specific period by the total number of sales in that same period.
Total revenue ÷ total sales = APV
So if you made $25,000 in revenue in one month from 100 sales, your APV would be $250.
Estimate the Average Purchase Frequency Rate
The average purchase frequency rate (APF) is a metric that measures customer loyalty. Businesses can use this metric to uncover trends in customer buying habits and find ways to keep them coming back for more. It’s calculated by dividing the number of purchases made by the number of unique customers in the same period.
Number of purchases ÷ number of unique customers = APF
For example, if 100 customers make 500 purchases in a given period, their APF would be five. That means each customer purchased five times during that time frame.
Estimate the Average Customer Lifespan
The average customer lifespan (ACL) — how long do customers stick around? This metric helps companies get an insight into their customer relationships and allows them to identify areas where they can improve the customer experience.To figure it out, businesses must measure the length of each customer relationship and then divide that total by the number of customers.
Total of customer lifespans ÷ total number of customers = ACL
Calculate Your Customer Lifetime Value
The CLV formula is a powerful tool that helps you identify high-value customers, determine how much to invest in acquisition, and build brand loyalty. The formula for calculating CLV varies depending on the industry and the size and complexity of your business.
However, a general formula for CLV is:
Average purchase value x purchase frequency x customer lifespan = CLV
For example, if your average purchase value is $50, average purchase frequency rate is two times per year, and average customer lifespan is five years, then CLV = $50 x 2 x 5 = $500.
Consider Gross Margin
But that’s not all! Including gross margin in your calculation of CLV provides insight into the profitability of a customer’s purchases, giving you an even more accurate representation of their value to your business.
Gross margin is calculated as net sales minus cost of goods sold, so if our example had 20% gross margin, then CLV = $50 x 2 x 5 x 0.2 = $100.
How to Improve CLV
One of your top priorities should be to improve the lifetime value of your average customer. Why? Because the higher the CLV, the more money you’ll make from each customer. But how can you improve this metric? Below, we provide you with a list of ways to improve this key metric. By implementing these strategies, you can increase your profits and build stronger customer relationships.
Focus on Customer Retention
Retaining customers is a more cost-effective strategy than acquiring new ones. Therefore, it makes sense to prioritize customer retention as a way to improve your CLV. You can do this by offering loyalty programs, providing exceptional customer service, and regularly communicating with your customers. By doing so, you keep your customers happy and increase the likelihood that they’ll purchase from you again.
Upsell and Cross-Sell
Another way to improve your CLV is by increasing each customer’s purchase value. You can do this by upselling, which means selling a higher-priced item to a customer already interested in buying something. You can also try cross-selling, which means suggesting complementary items to the product the customer is already purchasing. By doing so, you increase the total value of each sale.
Personalize Your Marketing
Personalizing your marketing efforts means tailoring your messages and offers to each customer’s preferences and behaviors. In other words, you speak directly to the individual’s needs and interests. This type of marketing can lead to more meaningful relationships between your customers and your business, which can improve their loyalty and increase their likelihood of repeat purchases.
Improve Customer Experience
The customer experience is the emotional impression a customer has after interacting with your business. To improve your CLV, you must provide a positive customer experience. This can be done by investing in the design and functionality of your website, providing easy checkout processes, and offering excellent customer service. Remember, a happy customer is likelier to return and make additional purchases.
Offer Subscription Services
Subscription services are a great way to improve lifetime value. By offering a subscription, you provide your customers with regular, recurring value, which can lead to long-term loyalty. Subscription services can be anything from a monthly box of products to access to exclusive content. Regardless of what you offer, the goal is to provide a valuable service that your customers find worth paying for.
Tools to Help You Calculate Customer Lifetime Value
With so many different formulas and factors to consider, it can be overwhelming to calculate CLV on your own. Fortunately, there are a variety of tools available to make this process easier and more accurate.
Excel CLV Formula
For those who prefer to stick with what they know, you can use Excel to calculate this for you. Simply plug in your company’s data, including average purchase frequency, customer lifespan, and average revenue per transaction, and let Excel do the rest using a template or by typing in the formula. This tool is especially helpful for those who are just starting out and don’t yet have access to more advanced software.
ChartMogul
ChartMogul is a popular subscription analytics tool that offers a simple and intuitive interface for calculating CLV. In addition to providing detailed reports on customer activity and spending, this platform allows you to segment your customer base and track revenue over time. While it may be a bit pricier than other options, ChartMogul’s robust feature set could be a great investment for you, depending on your needs.
Kissmetrics
Like ChartMogul, Kissmetrics is a subscription analytics software that provides insights into customer behavior. Its CLV calculator takes into account a variety of factors, including acquisition costs, retention rates, and average revenue per user. The platform also allows you to create custom cohorts and segmentation, making it a great choice for businesses with complex customer structures.
Google Analytics
While Google Analytics is primarily known for tracking website traffic, it also offers powerful features for calculating CLV. By setting up goals and tracking specific customer behaviors, such as repeat purchases or time spent on site, you can better understand how much value each customer brings to your business over time. Best of all, Google Analytics is completely free to use.
Frequently Asked Questions
What Is Meant by Customer Lifetime Value?
Customer lifetime value is the total revenue or value generated by a customer during the entire period of their relationship with the company. It indicates the long-term potential of consumer relationships and is used to measure the success of marketing campaigns.
Why Is Customer Lifetime Value Important to Know?
Customer lifetime value is a metric used to estimate the total value of a customer over the course of their entire relationship with your business. This data can be used to create more personalized marketing offers and make strategic decisions that maximize long-term growth for your company. CLV is important because it encourages you to view customers as long-term relationships instead of one-time purchases.
What Is an Example of Customer Lifetime Value?
An example of customer lifetime value is a business calculating how much revenue it can make from a customer over the length of its relationship. For instance, a restaurant can determine its CLV by tracking how many times a customer visits and their average spend per visit to reach a total expected lifetime revenue. This can inform marketing decisions, such as how much to spend on customer acquisition and retention. It can also identify which customers are most valuable and prioritize them for special offers or discounts.
How Is Customer Lifetime Value Calculated?
The customer lifetime value formula is used to estimate the total revenue that a business can expect from any given customer during the entire duration of their relationship. You can calculate it using the following formula: average purchase value x purchase frequency x customer lifespan = CLV.
Summing Up
In conclusion, knowing the lifetime value of your average customer is fundamental to driving business success. Determining what your customers are worth over a period of time is a great way to analyze and make key business decisions that can directly impact your bottom line.
Now that you know the answer to the question of what is customer lifetime value (CLV), you can understand customer behavior, identify your most valuable customers, channel marketing spending, forecast revenue, and prioritize business goals. Analyze and reconsider your CLV continually to improve your business performance and customer relationships. The sooner you get to know your CLV, the better your chance of benefiting from its insights.