Calculating Customer Lifetime Value is a widespread practice among both e-commerce business owners and marketers. However, not everyone approaches this metric with the same mindset.
The value of the CLV doesn’t lie in finding ways to acquire customers, cheaper. It lies in optimizing customer acquisition costs.
If you’re in the eCommerce game, you can’t afford to go on without understanding the impact of your Customer Lifetime Value.
“Making customers better makes better customers”Michael Schrage
In his book “Who Do You Want Your Customer To Become?”, Michael Schrage pointed out that making customers better makes better customers.
Therefore, innovation must be seen as an investment in human capital and customers’ capabilities. But first, let’s see what customer lifetime value is.
What is the Customer Lifetime Value
The CLV is defined as the prediction of the net profit attributed to the entire future relationship with a customer.
CLV is one of the key metrics which needs to be monitored as part of the customer experience program as it reveals how valuable a customer is to a business for an unlimited period of time as opposed to referring to their first purchase solely.
How to calculate the customer lifetime value
The simplest formula would be:
CLV = customer revenue – the cost of acquiring and serving that customer
Let’s say every year, for Mother’s Day, you send your mother the same $70 flower bouquet. If you’ve been doing this for the past 5 years, your lifetime value for your florist is $350.
However, this simple formula does not always apply as most businesses are more complicated than that. So two other methods have been proposed: historical and predictive CLV.
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The historical CLV is the sum of the gross profit from all historical purchases for an individual customer.
Determining the customer lifetime value based on profit shows you the actual profit a customer is bringing to your store. To determine the historical CLV, first you need to:
- Identify the touchpoints where your customer creates value;
- Integrate records and create a customer journey;
- Measure your revenue at each touchpoint;
- Add everything over the lifetime of that customer.
Then, you can use the formula below:
Historical CLV = (Transaction 1 + Transaction 2 + … + Last transaction) * Average gross margin
The historical CLV takes into account customer service costs (cost of returns, acquisition costs, cost of marketing tools, etc.). The problem with this method is that it can be complicated to calculate on an individual basis, especially if you want the figures to constantly be up to date.
A more efficient way to determine the customer lifetime value is through predictive CLV.
The predictive CLV is built based on predictive analysis and takes into account previous transactions plus various behavioral indicators that forecast the lifetime value of an individual.
This value becomes more accurate with every purchase and interaction, so this is a better method to calculate customer lifetime value.
To calculate the predictive CLV you need to:
- Identify the touchpoints where your customer creates value;
- Find out what determines that value and if it differs from customer to segment;
- Identify why a customer has moved from one moment to the next.
Then, you can determine the predictive CLV in two ways:
Simple predictive CLV:
CLV = ((Average monthly transactions * Average order value) * Average gross margin) * Average customer lifespan
*where the average customer lifespan is calculated in months. This formula is also used to determine the detailed predictive CLV, so let’s call it CLVs.
Detailed predictive CLV:
CLV = CLVs * Monthly retention rate1 + Monthly discount rate – Monthly retention rate
One thing to keep in mind when calculating the predictive CLV is that it will never be 100% accurate as this is just a forecast.
However, if you personalize the formula for your business, you can determine a highly-accurate customer lifetime value.
Also, note that the equations above don’t take into account the cost associated with retaining a customer.
To get a net value for your CLV, you will also need to calculate this. And if you really want to be accurate, you may also want to consider interaction and transactional information for each customer, as every individual is unique.
Lifetime value to Customer Acquisition Cost Ratio
The ratio between CLV and CoCA (customer acquisition cost) is one of the most important aspects that a VC will look at before investing in your company.
You simply can’t acquire customers forever. So finding the right customer acquisition and retention mix is the key for a sustainable for eCommerce growth.
A good ratio would be 2, a bad one would be below 2 and the best ratio is 3.
If it is below 2, that means your either doing this consciously in order to gain market share, either your business is bleeding money.
If it’s above 3, it usually means you’re either harvesting cash because your business can’t grow anymore as you are the market leader and don’t want to diversify.
Another possible explanation for this value could be the fact you’re too prudent and don’t want to grow faster, or you’re not aware of this and you don’t want to go faster.
The basic rule in poker is to look at your own cards. If you’re in the eCommerce game and you don’t know this ratio, it means you’re breaking this rule.
Customer lifetime value benchmarks
After all the effort you put in to determine your CLV you might also want to know where you stand compared to your competitors.
Although each e-commerce business is different and their customer lifetime value varies, there are some benchmarks you can use to roughly estimate your position.
According to the 2015 E-commerce Growth Benchmark Report – RJMetrics, for best-in-class e-commerce companies, the average customer lifetime value is $3,600. Across all companies, the CLV is about $1,300.
To put things into perspective, Amazon Prime has a CLV of $2,500, while non-Prime stops at $1,000 with a CPA of $160.
Customer lifetime value analysis (Case Studies)
If you’re interested in the thought process behind an CLV analysis, we’ve detailed it in this article: Customer lifetime value analysis in Reveal vs Excel
Starbucks is always opening new stores around the world, its acquisition strategy being frequently copied. For this case study, I am going to use data from 2004. The numbers do not reflect the company’s current status, but they can be used to exemplify how you should determine your customer lifetime value.
Step 1: Find out your average
To simplify calculations, let’s say you only have three customers. Customer 1 spends $4 per visit. Customer 2 spends $6 per visit. And customer 3 spends $9 per visit. The average will be $6.33 (I’ll call this value ‘s’, the average spend per customer).
Now, for the purchase cycle, customer 1 visits you 5 times a week, customer 2 visits you 3 times a week, and customer 3 does it 6 times a week. The average number of visits is 4.66 (I’ll call this ‘c’).
Last but not least, your average customer value per week (expenditures * visits) is $20 for customer 1, $18 for customer 2, and $54 for customer 3. The average across the three customers is $30.66 (I’ll call this value ‘a’).
Step 2: Calculate the CLV
To determine the customer lifetime value, I will also use some constants:
Average customer lifespan (t) = how long an individual remains a customer. For Starbucks, that’s 20 years.
Customer retention rate (r) = the percentage of customers who repurchase over a given period of time when compared to an equal preceding period. Starbucks’ retention rate is 75%.
Profit margin per customer (p) = For Starbucks that’s 21.3%.
Rate of discount (i) = the interest rate used in discounted cash flow analysis to determine the present value of future cash flows. Usually, the rate of discount is between 8% and 15%. For Starbucks, it’s 10%.
Average gross margin per customer lifetime (m) = Starbucks has a profit margin of 21.3% (p). If the average customer spends $31.886 (52 * a * t) during their life as a customer (t), Starbucks has a gross margin per customer lifespan of $6.791 (profit margin * expected customer lifetime expenditure).
A large corporation like Starbucks will use several methods to determine the customer lifetime value, as well as marketing budgets and acquisition costs.
Determining your customer lifetime value is just the beginning. What you do with that information is what will determine your business’ success. Because now you know how much you should be spending to acquire a customer, from overhead to marketing.
Let’s look at Netflix. An average Netflix subscriber stays on board for 25 months and has a lifetime value of $291.25.
If you’d subscribe to Netflix right now, you would pay around $8.97 per month (that’s the cheapest price plan), which means $107.64 per year. If you were Netflix, would you spend $150 to acquire a customer?
It seems counterintuitive to spend more to acquire a customer and still be profitable, but that’s why determining your customer lifetime value is important.
Yes, Netflix would lose $42.36 in the first year, but as I mentioned earlier, the average Netflix user stays a customer for 25 months. So even if the company doesn’t make an immediate profit, it doesn’t mean it remains unprofitable.
You shouldn’t be afraid to lose money in the short run if that can boost your revenue in the long run.
In order to determine how much you can afford to lose in the short run, you need to know the lifetime value of your customers. Without that number, it’s impossible to optimize your revenue.
Maximizing the customer lifetime value
Each customer is unique. Some will not pay for Netflix; not even for a month. Some might remain customers for several years, while some might never want to cancel their subscription.
Not to mention that Netflix offers three different price plans – a premium user who remains a customer for three years is more valuable than a customer who has the cheapest price plan for four years.
By tracking each customer individually, Netflix can optimize their lifetime value. For example, if you stop watching movies, they know you might cancel your subscription sooner or later.
So, they can start persuading you into remaining a customer long before you even think of canceling your subscription. By tracking stats and behavior of users, Netflix is reducing its churn rate.
To maximize your revenue per customer you need to track each individual. By monitoring the specific events and actions your customers are taking on your website, you can determine the steps or features that will influence people to engage more.
Users that engage more are happy customers, and happy customers will remain with your company for longer.
Maximizing customer acquisition
Netflix knows their customer lifetime value and has fine-tuned their product to reduce churn so they can afford to spend more on marketing. For example, they pay affiliates $16 for every customer they bring in.
It might not seem that much, but take into consideration the fact that Netflix offers the first month for free and many users don’t turn into paying customers after that.
So, affiliates are paid $16 for each user no matter if those users become profitable or not.
However, a percentage of those users actually do turn into paying customers. Otherwise, Netflix wouldn’t be able to keep paying affiliates $16 or spend $2 for every click from their Google AdWords campaign.
The point I want to make is you can’t keep dumping money into marketing if you don’t know your lifetime value metrics well.
Customer lifetime value optimization
It’s cheaper to retain existing customers than to acquire new ones, especially in industries where the customer lifetime value is more important than the profit of an individual sale. Globally, the average cost of a lost customer is $243 (KISSmetrics).
64% of companies rate customer experience as the best tactic for improving customer lifetime value, followed by better use of data and personalization. There are many methods you can use to optimize your customer lifetime value, but here I will detail a few:
1. Treat your best customers differently
How would you call a world where everyone gets the same reward. No matter how impactful they are? Where everyone gets the same bonus, no matter how hard they work?
Well, if your eCommerce is sending the same special offers and discounts to all their customers, that’s what’s happening.
A good idea would be to incentivize customers to like you more by giving them special treatments, ultimately, increasing your chances of turning them into advocates.
That’s exactly what Booking.com is doing with their best customers through their Genius program.
2. Offer a personalized experience
94% of businesses believe that personalization is critical to current and future success.
Let’s take a look at a case study we’ve made for Avon. Based on online surveys, the data showed that the most important barrier women had in order to buy from Avon was their distrust that the make-up will match their eyes color.
So, an actual beauty expert showed up on a triggered overlay to help them out:
The website displayed only relevant products for their eyes color, remaining consistent on the checkout:
3. Offer free returns
Free returns mean additional costs for you. But these costs need to be considered together with the extra conversions they bring and the potential to boost the retention rate.
However, to identify to whom you should offer free returns and to optimize the kind of products you are selling, you need to do deep diving into data.
Did you know that… we empower eCommerce companies to monitor all these great metrics here at Omniconvert to help eCommerce websites extract this kind of data insights from their data. It is called Reveal, and it is a Customer Intelligence platform that’s already directly integrated with Shopify.
If you’re on a different platform, you can easily integrate it with any other platform – set up your account here>
Zappos found out that people who regularly return items are their best customers. Those Zappon clients who buy the most expensive products are also the ones with an orders return rate of 50%.
“Our best customers have the highest returns rates, but they are also the ones that spend the most money with us and are our most profitable customers. – Craig Adkins of Zappos.
4. Address the reasons why orders are returned
For fashion e-commerce stores, one of the most frequent reasons items get returned is the size. So many stores have implemented fitting tools and virtual wardrobes that make up for the fact that customers cannot try on the clothes before buying.
Shoefitr, an app that helps online shoe shoppers find proper fitting footwear, managed to reduce the fit-related returns of an online footwear retailer by 23%.
Another example is GlassesUSA who lets its customers upload a picture of them and try on glasses before purchasing. And this strategy can be implemented for non-fashion related online shops as well.
MyDeco 3D room planner is another tool that helps online shoppers try out room looks before buying furniture.
5. Provide multi-channel returns
The fit is not the only reason items are returned. Since customers will return products anyway, you should make their experience as easy as possible.
If you are an omnichannel retailer, allowing customers to return items bought online to brick and mortar stores is a must.
Customers really appreciate the flexibility and convenience of multi-channel returns and are more likely to become loyal customers.
Think about it this way: when you allow your customers to return items in store you also take advantage of the opportunity to upsell or cross-sell; a well-thought multi-channel return strategy rarely lets customers leave the store empty-handed.
6. Reward your most loyal customers
Offering your most loyal customers some kind of reward is a powerful way to strengthen brand affinity.
Your loyal customers are your brand ambassadors. Your influencers. Some retailers offer special discounts or private sales, but it can be much simpler than that (like responding to your customers’ tweets).
ASOS has another strategy worth copying: creating an exclusive community for people who love the brand. The retailer launched #AccessAllASOS, a community that provides members exclusive access to news and events.
7. Focus on your ideal customers
The best in class retailers pay special attention to their VIPs by running RFM segmentation. RFM is a way to segment your customers according to their buying behaviors:
– Recency – How recent is the last order?
– Frequency – How often that customer bought?
– Monetary value – What is the total revenue you got from each customer?
Find more about this model in this short video explainer:
Loyal customers are valuable, but loyal customers who also spend a lot of money with you are even more valuable.
Here are a few benefits you can offer them after you will find out who they are:
- Priority Support
- Free returns
- Free delivery
- Tailor-made offers
- Packing and dispatching their orders first;
- Notifying them about new or limited products first;
- Sending them personalized lookbooks, exclusive previews, and presentations;
- Assigning them personal shopping assistants who can help them plan their wardrobes.
- Thank-you notes or gifts
If you are interested to understand more about your buyer persona, read this article regarding how to do it. You will be able not only to optimize lifetime value but also to acquire the customers your eCommerce needs.
8. Provide outstanding customer service
I don’t think there’s a brand out there that purposely provides bad service to its customers.
Nonetheless, there aren’t many retailers that provide excellent customer service either. But they should. A study by Zendesk revealed that consumers rank quality (88%) and customer service (72%) as the two biggest drivers of loyalty.
The same study also revealed that providing exceptional customer service 24/7 is the best way a company can build customer loyalty.
However, few companies are making efforts to understand how their customers are feeling after the purchase using customer surveys.
Measuring NPS or customer satisfaction or customer effort is an effortless way to stop broadcasting, but establishing a two-way communication model between you and your customers.
Moreover, if you mix RFM with NPS, you can reveal some hidden reasons why your CLV is being affected. Putting your customers first will not be an option in the near future. It will be a vital thing to do if you want your company to survive and thrive.
Most businesses try to reduce costs associated with customer support so they make it difficult for customers to actually speak to someone on the phone (marketers who have tried at least once to contact Facebook Ads support can surely understand how frustrating this feels).
So improving your customer service will also boost your customer retention rate and customer lifetime value. Also, social media is an increasingly popular support channel and many brands have a Twitter feed dedicated to resolving customer queries.
9. Acquire sticky customers
After you identify your ideal customer profile through RFM segmentation, you can improve customer acquisition by targeting the customers that are more likely to buy again from you.
You may think that you can find this kind of demographics data in your Google Analytics or Facebook Insights. But, the truth is that what you are seeing there is the data regarding your visitors, not your customers.
And the customers are what matters to you. Moreover, your best customers (true lovers) are the ones you should really focus your customer acquisition efforts.
10. Build a subscription model
You may not have control over the delivery process, but you can still improve how the package looks like.
Birchbox, a company that offers monthly subscription boxes of cosmetic samples, delivers a personalized selection with a beautifully written letter in a branded box made out of Birch trees.
Another well-known retailer who invests in his packaging is Net-a-Porter. Many customers are so in love with their beautiful boxes that they can’t help posting their orders everywhere on social media (which, by the way, is a great method to increase customer loyalty and advocacy).
11. Diversify your product offering
As you can see, optimizing your customer lifetime value goes hand in hand with optimizing your retention rate. And the retention rate is improved when you make your customers’ lives easier.
If you identify the buying patterns of your most important customers, you can free them from the need to use other websites or channels to acquire the goods they are in need.
Uber is one of the companies that have diversified beautifully.
From the need to get a ride to the need to get food delivered at your door.
Customer lifetime value is more important than you think. It impacts customer retention rates, it helps boost brand loyalty, and, overall, ensures your business remains profitable and increases the overall business valuation.
So, if you’re not actively monitoring and trying to improve your CLV, now is the time to start!
Frequently asked questions
Customer Lifetime Value or CLV is defined as a prediction of the net profit a customer can generate during the whole relationship with a company. The simplest formula for CLV is to extract the cost of acquiring and serving a customer from the customer revenue. Let’s take for example a pet owner who orders every month, for the past 3 years, the same product type and quantity of food that costs $100. If the cost of acquisition was $60, then the lifetime value for the petshop is $3,540.
Customer lifetime value is a metric that helps businesses measure, monitor, and predict the value a customer brings for the company through all the purchases she/he makes for an unlimited period. This predictive metric of the net profit a customer could generate helps you understand how well your retention efforts and loyalty programs work.
There are several ways that allow you to calculate customer lifetime value. The most simple formula is CLV = customer revenue – the cost of acquiring and serving that customer. But there are two other formulas that reflect the complexity of a business, historical and predictive CLV. The formula for historical CLV is (Transaction 1 + Transaction 2 + … + Last transaction) * Average gross margin. The formula for predictive CLV is CLVs * Monthly retention rate1 + Monthly discount rate – Monthly retention rate.
Customer lifetime value is one of the most important KPIs for a business and it measures the net profit a customer brings during her/his relationship with a company. CLV is important because it reflects how good businesses are at retaining customers and increasing their value in the long term. Monitoring CLV allows businesses to measure the success of their marketing efforts and to adjust tactics for CLV optimization.