Customer Lifetime Value: What It Is and How It’s Calculated
Becoming profitable is a crucial milestone for a startup, and increasing profitability is just as important for any organization. But it’s not as simple as just bringing in more money. You need to scrub through data and crunch numbers. Customer lifetime value, or CLV, is one of those numbers.
Evaluating customer lifetime value can help you determine what a potential or current customer is worth to your business. This can direct spending on marketing, customer service, and more, especially when combined with Cost of Acquisition, or CAC, understanding.
CLV is important, but it doesn’t need to be complicated! Let’s break down what CLV is, how it’s calculated, and how optimizing it can boost your company’s revenue.
What is customer lifetime value?
Customer lifetime value (CLV) is the total amount of revenue they will spend with a company over the length of their entire relationship.
For example, let’s consider a shoe store. If customers usually spend about $75 on sneakers, and tend to buy three pairs a year, then someone who’s shopped at this store for 10 years would have a Customer Lifetime Value of $2250. To consider a slightly different business model, an entertainment streaming service might offer a $9.99/month subscription. If most customers keep one subscription for three and a half years, their CLV is $419.58.
Expensive purchases do not automatically make for higher CLV. For example, a company that sells most clients one $2500 computer every three years may have lower-value customers than a coffee chain that sells multiple $5 coffees a week.
CLV helps companies uncover their ideal customer by defining the segments of their customer population that will bring the most value long-term. Then, they can tailor their marketing, customer service, product development, and other areas of operation to those customers’ preferences.
CLV is often considered together with Customer Acquisition Cost (CAC) to help companies make smart choices around attracting new customers and retaining their existing ones. It’s much more expensive to get new customers than keep the ones you already have, so CLV is a very important metric to growing revenue in a sustainable way.
How to calculate customer lifetime value
The basic calculation to find customer lifetime value is below.
CLV = (average purchase value X average number of purchases annually) X years in average customer relationship
While this is a simple formula, finding an accurate customer lifetime value is not always straightforward. Companies also need to calculate the values within the equation accurately, which may present its own challenges.
For example, finding CLV might be fairly simple at a direct-to-consumer goods company, but could be more difficult for a large company, or one with a more complex business model. Companies like this will likely need more advanced data-tracking or analytics tools to determine their CLV.
Customer Lifetime Value and Customer Acquisition Cost
By comparing CLV to Customer Acquisition Cost (CAC), companies can determine how much they can spend to gain a customer, typically through marketing costs, without losing profitability. No matter how much their customers spend, a company will always lose money if their CAC outstrips their CLV.
Acquiring new customers isn’t cheap — one study estimated that it’s 5 to 25 times more expensive to attract a customer than hold on to an existing one. That’s why it’s so important for businesses to find out who their high-value customers are, and invest attention and resources into keeping them.
Usually, CAC isn’t the same for every customer. Low-CAC customers represent more profits for a company, just like those with a high CLV do. This is why these two metrics are so powerful in tandem — to grow, boost profits, and reach its revenue goals, businesses should seek out high-value customers that cost as little as possible to acquire.
How to Improve Customer Lifetime Value
Because it’s so much more cost-effective to keep customers than gain new ones, improving customer lifetime value is a very important part of increasing overall revenue.
Boosting CLV comes down to three goals — increasing the average value of a customer’s purchase, increasing how many purchases they make in a year, or increasing the number of years that they shop with the company.
Many companies use upselling — suggesting additional products at the time of purchase — to raise their average purchase price. Another technique could be to analyze the preferences of high-value customers and use that information to release products tailored to them. To increase the amount of purchases their customers make, a company could try outbound marketing, such as offering discounts to customers who haven’t shopped in a while.
Good customer service is another key to improving CLV, because it can extend customer relationships and improve loyalty. When companies listen to their customers’ preferences, prioritize the quality of their experience, and resolve their issues, their customers are much more likely to continue doing business with them — this is also known as reducing a business’s churn rate.
Improving CLV comes down to treating customers well and listening to their needs. It’s common sense. If a company understands its customers and provides them with a positive experience, they’ll be much more likely to purchase from them again!
Happy customers, higher value
While the acronyms and formulas behind CLV might seem complicated, it’s really just a way to look at customer relationships holistically, rather than breaking them down into separate, disconnected transactions.
To improve CLV, companies must find their best customers, and incentivize them to keep coming back. Increasing customer value is about making money, but it also means providing a great service. In high-CLV relationships, clients get a high-quality experience that meets their needs, and companies get to keep growing, earning profits, and reaching their goals.