What is customer lifetime value (CLV)?
Customer lifetime value (CLV) is the total amount of money a customer is expected to spend on a business's products or services over the course of their relationship with that business.
It is a key metric for businesses to understand because it helps them determine the long-term value of their customers and the potential return on investment for acquiring new customers.
By calculating CLV, businesses can make informed decisions about marketing, customer acquisition, and retention strategies to maximize their profits over time.
Why Is customer lifetime value important to your business?
Customer Lifetime Value (CLV) is important because it helps businesses make informed decisions about how to allocate resources and make strategic decisions to maximize profitability over the long term.
Here are some key reasons why customer lifetime value (CLV) is important:
- Helps with customer acquisition: By understanding the potential value of a customer, businesses can determine how much they can afford to spend on marketing and advertising to acquire that customer. This helps businesses avoid overspending on customer acquisition and maximize their return on investment.
- Improves customer retention: By understanding the value of a customer over time, businesses can focus on retaining their most valuable customers. This can include investing in loyalty programs, personalized marketing, and customer service to keep those customers coming back.
- Guides product development: By analyzing customer behavior and preferences, businesses can develop products and services that are tailored to their most valuable customers. This can help increase customer satisfaction, reduce churn, and ultimately increase CLV.
- Determines pricing strategies: By understanding the value of a customer, businesses can set prices that reflect the lifetime value of that customer. This can help maximize profits over time and avoid underpricing products or services.
How to calculate customer lifetime value?
You can calculate CLV using multiple formulas, depending on the values you specifically want to measure. The following are some of the most commonly used CLV calculations that can help determine various figures based on past and future customer interactions.
Average Purchase Frequency Rate
You can calculate the average purchase frequency rate (APFR) to give you the average number of purchases during a particular period. The formula is as follows:
Number of Purchases / Number of Customers in a Given Period = Average Purchase Frequency Rate (APFR)
Average Purchase Value
This formula will indicate the average value of purchases within a specific sales period. The formula will look like this:
Total Revenue in a Given Period / Number of Purchases = Average Purchase Value (APV)
Customer Value
You can calculate the total value of your customers by using the following equation:
Average Purchase Value (APV) x Average Purchase Fraequency Rate (APFR) = Customer Value (CV)
Average Customer Lifespan
You can also calculate the average lifespan of your customers throughout their interaction with your brand and offerings. Use this formula to calculate ACL:
Total Customer Lifespans / Number of Customers = Average Customer Lifespan (ACL)
Calculation of Customer Lifetime Value
Using APV, APFR, and ACL based on the above formulas, you can calculate your CLV. You can easily calculate this metric for individual customers using the following formula:
Average Purchase Value (APV) x Average Purchase Frequency Rate (APFR) x Average Customer Lifespan (ACL)
Customer Lifetime Value Calculation Example
Here's an example of how to calculate Customer Lifetime Value (CLV):
Let's say a business has a customer who has made five purchases over the past year, with an average order value of $50. The business spent $20 to acquire the customer through marketing efforts. Based on historical data, the business estimates that the customer will continue to make an average of two purchases per year for the next three years.
To calculate the CLV for this customer, you would use the following formula:
CLV = (Average Order Value x Purchase Frequency x Customer Lifespan) - Customer Acquisition Cost
Using the data from our example, we can calculate the CLV as follows:
CLV = ($50 x 5 x 3) - $20
CLV = $750 - $20
CLV = $730
This means that the expected lifetime value of this customer is $730. The business can use this information to determine how much they can afford to spend on marketing to acquire similar customers in the future and to develop retention strategies to keep this customer coming back.
Of course, this is just a simplified example and the actual CLV calculation can be more complex depending on the business and the customer data available. But this gives you an idea of how CLV can be calculated and used to inform business decisions.
What is a good Customer Lifetime Value (CLV)?
There is no set benchmark for what constitutes a "good" Customer Lifetime Value (CLV) as it can vary widely depending on the business and industry. However, a higher CLV is generally viewed as more desirable as it indicates that a customer is generating more revenue for the business over time.
In general, businesses should aim to maximize their CLV by focusing on strategies to increase customer retention, cross-selling and upselling, and overall customer satisfaction. This can help ensure that customers remain loyal and continue to generate revenue for the business over the long term.
It's important to note that a high CLV doesn't necessarily mean that a customer is profitable for the business. Businesses must also consider factors such as customer acquisition costs, operational expenses, and other overhead costs to determine the true profitability of each customer.
Ultimately, the "good" CLV for a business will depend on its specific goals, strategies, and financial situation. By tracking CLV over time and comparing it to industry benchmarks, businesses can gain insights into the effectiveness of their customer acquisition and retention strategies and adjust their approach accordingly.
What factors affect customer lifetime value?
There are several factors that can affect Customer Lifetime Value (CLV), including:
- Purchase frequency: Customers who make frequent purchases are likely to have a higher CLV than those who make only occasional purchases.
- Average order value: Customers who spend more per order are likely to have a higher CLV than those who spend less.
- Customer retention: Customers who remain loyal and continue to make purchases over time are likely to have a higher CLV than those who churn quickly.
- Customer acquisition costs: Customers who are acquired at a lower cost are likely to have a higher CLV because they provide a higher return on investment.
- Customer referrals: Customers who refer others to a business are likely to have a higher CLV because they bring in additional customers who may also become loyal and make frequent purchases.
- Customer satisfaction: Customers who are satisfied with their experience are likely to have a higher CLV because they are more likely to remain loyal and make repeat purchases.
- Customer demographics: Customers with higher income or who fall into certain demographic categories may have a higher CLV than others.
By understanding these factors and how they contribute to CLV, businesses can make informed decisions about marketing, customer acquisition, and retention strategies to maximize profitability over the long term.
Strategies to improve Customer Lifetime Value (CLV)
There are several strategies businesses can use to improve Customer Lifetime Value (CLV):
- Increase customer retention
- Cross-selling and upselling
- Improve customer experience
- Focus on high-value customers
- Develop new products and services
Increase customer retention
Keeping customers loyal and engaged is key to increasing CLV. Businesses can achieve this by offering excellent customer service, personalized marketing, loyalty programs, and other retention strategies.
Cross-selling and upselling
Encouraging customers to purchase additional products or services can increase their overall value to the business. Cross-selling and upselling can be achieved through personalized recommendations, targeted marketing campaigns, and product bundling.
Improve customer experience
Providing a seamless and positive customer experience can help keep customers coming back and increase their overall value to the business. This can include investing in user-friendly technology, improving shipping and delivery times, and offering easy returns and exchanges.
Focus on high-value customers
By identifying and targeting high-value customers, businesses can allocate resources more efficiently and maximize their overall profitability. This can involve personalized marketing, exclusive offers, and other strategies to keep these customers engaged and loyal.
Develop new products and services
By continuously innovating and offering new products or services, businesses can keep customers interested and engaged over time. This can help increase CLV by encouraging repeat purchases and cross-selling opportunities.
Improving CLV requires a customer-centric approach and a focus on building long-term relationships with customers. By providing excellent customer experiences, personalized marketing, and innovative products and services, businesses can increase the lifetime value of their customers and maximize their overall profitability.
