What Is Customer Lifetime Value?
To lose and to win over customers is part of the history of absolutely any company on the planet. However, the fight for creating a better overall environment for your customers isn’t every company’s focus, and this is a wrong approach to business. Why is that? Because if you improve customer relationships it will prove to be very profitable in the long run. There’s a performance metric that measures this aspect exactly, and it’s called Customer Lifetime Value (CLV). You can sometimes find it referred to as Lifetime Value (LTV). However you call it, what it reveals to you is the estimation of the profit margin you can expect to earn through conducting business with your average customers.
Customer Lifetime Value is an extremely valuable metric to take into consideration for the success of your business, as such, calculating customer lifetime value should be a priority. There are plenty of reasons to do so, we will discuss them later. For now, it’s important to understand that in the world of metrics, CLV is sometimes treated as an underdog, which is a big mistake in our opinions. It happens so because many companies tend to struggle when it comes to properly define and calculate it.
We’re here to raise awareness on the Customer Lifetime Value metric and reveal its importance for your business. First off, and most important, it helps you understand if the marketing campaigns you employ truly drive customer loyalty, eventually increasing overall revenue. You have to be aware that a good marketer knows that it costs more to acquire new customers than to retain the existing ones. As such, the CLV must account for customer acquisition costs (CAC), ongoing sales and marketing expenses, operating expenses, and, of course, the cost required to manufacture the product and services the company is selling.
As stated, many companies are overlooking this valuable metric and instead optimize other aspects of their business in the near term. Of course, finding new customers shouldn’t be completely overlooked, as they are the key to the growth of the company, but optimizing the lifetime value of existing customers is crucial for a company to both grow and increase its revenue.
To be clear, Customer Lifetime Value refers to how much money a customer will bring to you throughout their entire time as a paying customer. As such, improving the customer relationship will increase the average customer’s lifetime value (CLV).
Why Is Customer Lifetime Value Important
The importance of customer lifetime can’t be denied. It has been proven in the past that even a small increase in Customer Lifetime Value rates (as low as 5%) can increase your profits anywhere within the range of 25% to 95%. With this in mind, it becomes obvious that increasing the expected customer lifetime value is crucial if you want to maximize your revenue. CLV should clearly be one of your main focuses from now on when it comes to allocating budgets for your marketing team. We can prove it in 3 short examples that add value to your company.
1. Optimizing CLV is the fastest path to increase your revenue
CLV, as stated before, is grown rather by focusing your marketing efforts on retaining customers, not on acquiring new ones. Don’t start your CLV optimization processes by thinking it will increase your customer database. It will rather make your current database much more profitable.
Investing in retention is a logically proven concept: If 1% of your clients return to your online shop after their first visit, this means a 10% increase in revenue. Retaining 10% of your existing clients will double your revenues.
Remember that even a small increase in Customer Lifetime Value rates (as low as 5%) can increase your profits anywhere within the range of 25% to 95%? Well, this is how, through increasing retention and reducing your customer churn rate.
2. Increase the chance for repeat customers
Besides being the fastest way to increase revenue, improving your CLV is also the easiest way to do it. One easy way to see this for yourself is if you are using an Activated Customer Data Platform, which can show you how your current CLV affects your short and long-term marketing efforts, as well as your short and long-term overall profitability.
The probability of selling to a new customer ranges from 5-20% (as in him going all the way down the sales funnel, past the checkout process, where most customers abandon it). Returning customers, on the other hand, besides having a vastly increased probability of buying your products again, also tend to spend an average of 67% more than first-time customers. Besides retaining them, focus on helping them become repeat customers.
3. Through CLV, both customer loyalty and company revenue increase
You may have heard of the intricate Pareto Principle, the one which hypothesizes that 80% of your revenue comes from 20% of your customers. It’s not surprising, given the information above, but to reach this point, you must go beyond retaining and creating repeat customers. The safest way to increase your CLV is by building loyalty in your customer database.
When you calculate your CLV, start by segmenting your highest-value customers. Why do this? To be able to better target them with special campaigns meant to increase their loyalty, thus increasing their sense of belonging to your brand and their overall spend.
More benefits and CLV optimization tactics will be discussed in the following. But first, let’s see how to calculate your Customer Lifetime Value.
How do you measure customer lifetime value?
Several different methods exist to calculate CLV, but after going through them, we will reach the simplest customer lifetime value formula. For starters, the CLV calculus can either be historic or predictive. To be more precise, you can either calculate your CLV based on the history of actual purchases or based on what you predict your customers will spend. The way you calculate it will also vary depending on what business model you employ. It’s much easier to calculate CLV if you have a subscription model than being in eCommerce since sales can become more predictive.
Regardless if you use the historic or predictive method, you have to start from knowing the following:
- Your average gross margin for purchases
- The average order value
- The purchase frequency
- The customer lifespan
- The number of customer you have
To start calculating the historical customer lifetime value, multiply the sum of all transactions with the average gross margin.
(1st transaction + 2nd transaction + … + Last transaction) * Avg. gross margin = hist.. CLV
Remember that customer lifetime value is a financial projection, requiring a certain deal of informed assumptions to calculate lifetime value. Since the lifetime value of a customer is taken into consideration in the form of gross revenue, it will not take operating expenses into account. (eg. how much did it cost the company to create the product, then advertise it). Don’t forget to take these operating expenses into account when calculating your real customer lifetime value.
To calculate the predictive customer lifetime value, the formula is Purchase Frequency multiplied by Average Order Value, Gross Margin and Customer Lifespan, all divided by the number of new customers per analyzed period.
pred. CLV = (Purchase frequency x AOV x Gross Margin x Customer Lifespan) / Number of new customers
The Purchase Frequency is the division of the total number of orders made by new customers by the total number of new customers per analyzed period.
The Average Order Value represents all the revenue divided by total number of orders.
The Gross Margin – to calculate it, you will need the COGS. It is what remains from the total revenue after you exclude the cost of the goods sold from the total revenue (excluding the cost with the returns).
The formula for Gross Margin is 1 – COGS / Net revenue.
Customer Lifetime Span – that is the average number of years that a customer is expected to buy from you, taking into account the customer retention rate.
The formula for it is 1 / (1 – Customer Retention Rate).
Last, but not least, the customer retention rate is calculated as Customers with 2+ orders / Total Customers.
You can learn a lot more about calculating and applying CLV by checking the up-coming Customer Value Optimization Course. The Super Early Bird price is just about to be launched, so stay tuned!
You can learn everything you need to know to make any eCommerce more profitable and sustainable using the power of customers by becoming a Certified Customer Value Optimization Expert.
How to boost your CLV
Now that you can properly calculate your CLV, let’s take a look at 6 great tips to improve it to improve your customer lifetime:
1. Segment Your Customer Base
Whether you’re using email or SMS channels to promote your products or services, you have to pay close attention to segmenting them based on age, interests, and especially financial power. Higher financial power means more purchase value from valuable customers. You simply can’t send the same message both to an 18-year-old and a 60-year-old if you want to increase your CLV.
Different groups of customers need different incentives to feel motivated to go higher up the sales funnel, and you will get the hang of it by analyzing customer data. Use original content for each segment group and don’t focus on forcing sales on them, instead, try to cultivate a calm relationship with your customers. Give them the feeling that you are always there for them and that there is no rush. Unless you specifically want to go into FOMO (Fear Of Missing Out) marketing.
You also need to take close care of the repeat customers segment as they represent a very important customer profile with great customer value. Keep in closer touch with them and try to bring them back to your site for more purchases. This is very important, as many marketers focus solely on bringing in new customers, forgetting about retention and customer churn rate avoidance.
2. Build Products or Services That Complement Each Other
The number of products or services you sell depends on many factors, especially if the existing customer is likely to buy more of these certain products or services. It depends on the nature of the item, you will always sell more napkins than computers, for example.
As such, creating products that complement each other is a great way to increase your CLV by incentivizing your existing customer database to come back for more added utility.
If this isn’t your company’s case, and you are selling one great product that people buy over and over again and have no need to create new ones, try to focus on recommending your product as a potential gift for others.
3. Send Out Coupons and Special Offers
Coupons are still vastly underrated, even though they have proven their efficiency many times in the past as a way to boost customers. People are all-in for getting special deals and discounts – and this also contributes to increasing their brand loyalty. Even a 10-percent-off coupon can help, and will still net you a great profit due to incentivizing people to make a certain purchase.
If you want to increase your customer lifetime value, sending a coupon code or a special offer during the month of their purchase is a great idea, since the transaction is still fresh in the customer’s mind, making him more willing to become a repeat customer.
Encouraging the customer to spend more money, by offering all kinds of special discounts or product/service packages will visibly increase your CLV Product and your overall revenue.
4. Thank-You Emails are Important
Gratitude is amazing for a customer, as it makes him feel the money spent wasn’t absorbed by a black hole, but by a company run by men or women like him. Besides, it helps with keeping in touch with your customer base, thus increasing your customer experience throughout your customer base.
The thank-you email is the message sent immediately after a purchase is made and helps the customer feel at peace with the deal they just made, while also making your brand remain fresh in their minds. Afterward, you can send optional customer surveys to make sure their purchase went well, thus increasing your presence even more and adding to the customer journey even after it has ended.
5. Employ Loyalty Programs
Perhaps the most important thing that factors in when optimizing your Customer Lifetime Value is offering rewards in exchange for purchases. These increase loyalty and such loyalty marketing campaigns should especially target your high-value customer segments. It is shown that around 70% of high-value customers will become repeat customers when presented with direct, special reward benefits when making a purchase.
Providing incentives for a repeat purchase is an effective way to boost your CLV. Tailoring these incentives according to your segmentation, thus reaching the unique needs of certain customer groups creates a much stronger relationship with them.
And this relationship is built through Customer Loyalty Programs, the greatest driver of CLV improvement. It will increase your Net Promoter Score and will also increase customer success and overall customer satisfaction.
The customer lifetime value reveals to you the estimation of the profit margin you can expect to earn through conducting business with your average customers.
If your average order value is $300, the average purchase frequency of your product is twice per year, and you know the fact that your average customer lifetime is 3 years, this gives you a final CLV of $200.
Several different methods exist to calculate customer CLV, they can either be historic or predictive. Remember that customer lifetime value is a financial projection, requiring a certain deal of informed assumptions. To start calculating the predictive customer lifetime value, the formula is Purchase Frequency multiplied by Average Order Value, Gross Margin and Customer Lifespan, all divided by the number of new customers per analyzed period
pred. CLV = (Purchase frequency x AOV x Gross Margin x Customer Lifespan) / Number of new customers
Customer lifetime value is an estimation of the profit margin you can expect to earn through conducting business with your average customers.
The average customer lifetime value is a more specific metric that solely depends on the type of business you run and on the domain you are active in.
Customer lifetime value estimates the profit margin you can expect to earn through conducting business with your average customers.
It’s important because even a small increase in Customer Lifetime Value rates (as low as 5%) can increase your profits anywhere within the range of 25% to 95%.