Customer Lifetime Value is a sales KPI and one of the vital aspects for any business looking for sustainable growth.
It impacts customer retention rate and helps boost brand loyalty. So, why wait? Start actively monitoring your customer’s lifetime value, take necessary measures to improve this metric, and let your business thrive.
Tracking a CLV reveals the untapped potential hiding in your existing customers. Also, it is the best measure to mitigate customer churn before you recoup the overall investment you’ve made to earn their business in the first place.
But while the concept of tracking the customer’s lifetime value seems interesting at first glance, estimating this metric requires careful planning.
This guide covers everything you need to know about this valuable performance indicator. Continue scrolling the page and learn exactly how to calculate and improve CLV.
What is Customer Lifetime Value?
Customer Lifetime Value, popularly known as the CLV, is the profit margin a company expects to earn from a single customer throughout the business relationship. This marketing KPI considers a customer’s revenue value and compares it to a company’s predicted customer lifespan.
When calculating CLV, you must account for customer acquisition costs, ongoing sales, marketing and operating expenses, and the cost required to manufacture the product.
The Short-sighted approach
Most companies take a short-sighted approach by overlooking this valuable metric. However, it’s essential to track the CLV not just to retain the existing customers but to find new prospects in the journey.
Calculating the customer lifetime value during any period is important for business. But it can offer you an extra metric for prioritizing high-value customers during an economic downturn. Knowing the CLV helps you optimize resources to maximize profitability and long-term success.
Below are mentioned four factors that could impact your customer’s lifetime value.
Customer Behavior: It is associated with his buying pattern, average order value, and the category of services he buys – Customer Behavior Analysis
Economic Factors: This might include inflation or changes in customer preferences.
Customer Satisfaction: Refers to the connection between satisfaction and repeat purchases or referrals.
Competition: This factor indicates the risk of customers switching to competitors offering identical products or services.
The Benefits of Tracking CLV?
Here’s a quick rundown of the four immediate benefits of tracking your CLV.
It helps increase revenue
CLV and revenue are co-related and directly proportional. The higher the customer lifetime value, the more revenue you can generate from that specific buyer. Using this valuable metric, you can take vital sale audits and marketing activities contributing to more purchases. Eventually, tracking this value helps reduce churn while increasing customer retention and loyalty.
CLV helps reduce acquisition costs
The insights you get from the CLV can help you improve your products and services. It further helps you increase customer satisfaction and the likelihood that they will generate referrals.
This metric lets you know about the high-value customers, thus making it easier to plan resource-spend more efficiently.
It helps you track the best products
Calculating the customer lifetime value will help you know which products and services contribute to retaining customers. Besides, this value offers you an industry perspective on your business. You can use the calculated metric to analyze product development efforts and understand how to use customer insights to build new marketing strategies. It also helps you know why your customers gravitate toward that specific product.
Leads to sustainable growth
The higher value you generate from a single customer, the more resources you have to invest in retention and hiring talent to fine-tune your strategies. Hence, calculating the customer’s lifetime value eventually leads to sustainable growth.
How to Calculate the Customer Lifetime Value?
CLV can be determined at an organizational level, a customer segment level, and an individual level. Let’s start with a company-wide CLV. But before we rush down to the formula, it’s vital to gather a few essential data pieces to get started.
Average Purchase Value: Refers to the customer purchases over a particular span, divided by the total purchases in that period.
Customer Value: It is the average buying frequency multiplied by the average buying value.
Average purchase frequency: It can be calculated by dividing the number of purchases in a specific time by the total number of individuals who made a transaction over the same period.
Average customer lifespan: the average time a customer continues buying from you.
Now you’ve got all the foundations, let’s move on to the magic formula to calculate the Customer Lifetime Value (CLV).
Note: asterisk (*) represent a multiplication (x)
CLV formula
Customer Value * Average Customer Lifespan
The result is a monetary value and reflects how much the average customer can spend with you over their lifetime.
Since this metric is a financial projection, businesses should make informed, data-backed assumptions. For instance, a company must estimate the average sale value, the average number of transactions, and the duration of the business relationship with a specific customer.
However, this simple formula doesn’t always apply, as most businesses are more complicated than that. Hence, we have compiled two other methods to calculate this valuable metric. These are Historical CLV and Predictive CLV.
Historical CLV
It is the sum of gross profit from all historical purchases of an individual customer. Calculating the historical CLV shows you the actual profit a customer brings to your business. To determine the historical CLV, you just need to:
- Evaluate the touchpoints where your customer creates value.
- Integrate records and create a prospect’s journey.
- Determine your revenue at each point.
- Include everything over the lifetime of that customer.
Once you finish this, calculate the final value using the formula below.
Historical CLV formula
(Transaction Value 1 + Transaction Value 2 +……+ Last Transaction) * Average Gross Margin
Average Gross Margin
Historical CLV considers the customer service cost, such as the cost of returns, marketing, and acquisition costs. However, this method comes with certain shortcomings. It can be complicated and time-consuming to evaluate historical CLV on an individual basis, especially if you want figures to be up-to-the-mark.
Predictive CLV
Since calculating Historical CLV can be challenging, most businesses prefer the Predictive CLV method to determine the customer lifetime value. It is based on predictive analysis and takes into account previous transactions plus behavioral factors forecasting the lifetime value of an individual.
This metric becomes more accurate with every purchase and interaction, making it effective and better than its counterpart. To calculate the Predictive CLV, you have to
- Identify the points where your clients create value.
- Check what determines that value and whether it differs from customer to segment.
- Determine why a customer has moved from one moment to another.
You can calculate the Predictive CLV in two ways, Simple Predictive CLV and Detailed predictive CLV. Scroll down and learn about both methods here.
Simple Predictive CLV
The mathematical expression to calculate the Simple Predictive CLV is
(Average monthly transactions * Average Order Value) * Average Gross Margin * Average Customer Lifespan
Detailed Predictive CLV
The simple formula for Detailed Predictive CLV is
CLVs X Monthly Retention Rate1 + Monthly Discount Rate – Monthly Retention Rate
When estimating the Detailed Predictive CLV, remember it will never be 100% accurate. It is simply a forecast and can offer you an approximate value.
Tips to Increase CLV
Now that you know the formula for calculating the CLV, it’s important to know if you can increase the customer’s lifetime value. So, here are some strategies that may help you achieve the target.
Optimize your onboarding process
Customer onboarding is bringing your customers up to speed with your brand. The process starts in the first few days after a customer makes a purchase.
When he returns to your website for other products or connects with you via email, he wants to understand how your company works and what you can offer. In that case, you must use customer data to offer great deals. Follow up with email contacts to know about their previous purchase experience.
Optimizing the onboarding process establishes a framework for long-term customer relationships that help increase CLV over time.
Embrace customers’ advice
Sometimes, it’s better to listen than talk. Customers often have good advice on how you could improve business practices to better serve your customers. So, give them room to add ideas and embrace their suggestions to improve things.
Start a loyalty program
Rewards or a customer loyalty program is the best way to make your clients feel valued. Recognize the most valuable customer segment that sticks with you in thick and thin, and pamper them with rewards or early access to your latest products. It improves long-lasting customer relationships while reducing your churn rate.
A company that figures out the CLV can easily align marketing solutions with its customer retention strategy. Make sure to include the client’s feedback in your overall business strategy.
