As a business owner, you might be tracking multiple metrics to identify what is and isn’t working for your business. However, among all metrics, one special metric that can tell you the value a customer brings to your business is “Customer Lifetime Value (CLV).” Understanding CLV can help you identify and target your most valuable customers, predict future revenue and make informed marketing & investing decisions.
In this blog, let’s find out what Customer Lifetime Value is, how to calculate it, its importance, and some effective strategies to improve customer lifetime value.
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What Is Customer Lifetime Value (CLV)?
According to Gartner, Customer Lifetime Value is defined as –
“The total revenue or value of a customer relationship over a lifetime”
In simple terms, Customer Lifetime Value or CLV measures the total value a customer will bring to your business over the entire duration of their relationship (with your business). CLV is a critical metric to measure because it will help you predict future revenue and long term business success.
For example, knowing the lifetime value of a customer helps you get answers to these questions:
- How much should you spend on sales and marketing?
- What revenue and profits can you predict in the future?
- How can you optimize customer acquisition cost for maximum value?
- How much money should you spend on customer acquisition?
In other words, once you have a fair idea about CLV, you can make much more informed decisions about resource allocation and optimization of your sales and marketing efforts.
How To Calculate Customer Lifetime Value?
Before we dive into the formula of Customer Lifetime Value, you must know about the two models to measure the value of your customers. They are:
- Historical Model: This model uses historical data to estimate the value of your customer over their lifetime. It is calculated based on past spending patterns, retention rates, and other factors that have been observed for the customer.
- Predictive Model: This model applies regression and machine learning techniques on new and existing customer data to predict future customer behavior. This technique helps in forecasting the future lifetime value of the customer.
Customer lifetime value formula
The Customer Lifetime Value can be calculated by multiplying the Customer Value by the Customer Lifespan.
Customer Lifetime Value = Customer Value X Average Customer Lifespan
Let’s break down the customer lifetime value formula,
Here, Customer Value is the revenue that a customer is expected to generate throughout their relationship with your business. We can calculate customer value by multiplying the Average Purchase Value and the Average Purchase Frequency Rate.
Customer Value = Average Purchase Value (APV) X Average Purchase Frequency Rate (APFR)
Average purchase value
Further, you can calculate Average Purchase Value by dividing the total revenue of your company in a particular period (usually a year) by the number of orders in the same period.
Average Purchase Value = Total Revenue/Total Number of Orders
Average purchase frequency rate
The average Purchase Frequency Rate can be obtained by dividing the number of purchases by the number of unique customers during that period.
Average Purchase Frequency Rate = Number of Purchases/Number of Customers
Average customer lifespan
In the customer lifetime value formula, Average Customer Lifespan is the length of time that a customer is expected to remain with a business. You can calculate this number by averaging the number of years a customer keeps buying from your company.
Average Customer Lifespan = Sum of Customer Lifespan / Number of Customers
Customer Lifetime Value Example
Let us consider a simple example to explain the above customer lifetime value. Imagine you own an eCommerce clothing store.
- Your customer spends INR 1000 per visit on average (this is the Average Purchase Value).
- He visits your store approximately two times a month (this is the Average Purchase Frequency Rate).
- So the Customer Value is around INR 2000.
- On average, your customer stays with your business for around four years (this is your Customer Lifespan.)
- Using the above formula, the Customer Lifetime Value for this consumer will be INR 2000 x 12 months x 4 years = INR 96000.
Why Is Customer Lifetime Value important?
It helps you optimize your marketing spend
The whole point of calculating the CLV is to optimize your sales and marketing spend. When you understand your CLV, you will be able to focus your efforts on acquiring and retaining the most valuable customers of your business instead of wasting it on customers with a lower value. You will be able to optimize your budget so that you get the most out of your efforts, which, in turn, will improve your bottom line.
It creates a steady cash flow for your business
A steady cash flow is crucial for your business as it ensures you have the resources to meet your company’s financial obligations as they come due. You need a steady cash flow to pay bills, make payroll, and invest in new opportunities. With the help of CLV, you can identify your repeat customers who will continuously pump cash into your business, resulting in a steady cash flow. You can attract customers with better offers and more personalized experiences so that they continue to purchase from you.
It helps you make better decisions about pricing and promotions
The price you set for products and the promotions you run can significantly impact your profitability and competitiveness. When you understand the CLV of different products and categories, you can make better decisions about product pricing and promotions. For example, if the CLV of a particular product is high, you can charge a higher price, not run any promotions, and still sell.
Increasing CLV can help reduce customer acquisition costs (CAC) and churn rate
When your CLV is high, your customers are more likely to remain loyal to your business. This not only translates to a lower churn rate but also means you need to spend less money on acquiring new customers to replace the existing ones. Also, higher CLV customers are more likely to bring more new customers through word of mouth, which can further help reduce CAC. A higher CLV customer may also be less sensitive to pricing. This means there will be minimal impact on the churn rate when you decide to increase the prices or make some other changes.
CLV helps identify areas of improvement
CLV is a valuable tool for identifying areas of improvement in your business. Different values and trends in CLV can highlight various issues in your business. For example,
- Low CLV indicates that your business is not retaining customers or you are targeting low-value customers.
- Declining CLV indicates that your business is slowly falling prey to rising competition, changing customer preferences, or even declining product quality or customer service.
- Uneven CLV indicates that some segments of your target audience are less valuable than others. Which means you are not effectively targeting and serving your most valuable customers.
Long story short, by analyzing your CLV, you can identify different areas of improvement in your business and take necessary steps, like changing customer acquisition and retention strategies or adjusting product offerings, to solve them.
How To Improve Customer Lifetime Value?
Here are 5 simple hacks to improve the CLV of your business –
Create a great onboarding process
Customer onboarding is the process of introducing a new customer to your business (and your products) and helping them become familiar with it. The goal of customer onboarding is to ensure that the customers can get the most out of your brand by understanding what your brand does, why it matters, and why they should stick around with your business. A smooth onboarding customer experience will increase their likelihood of becoming long-term and loyal customers.
Why does this work?
By creating a great onboarding process, you make your customers feel welcome, supported, and valued. It will directly impact customer satisfaction, which, in turn, will result in a higher CLV.
Craft a loyalty program and reward your customers
A loyalty program is a rewards program that incentivizes customers to continue doing business with your brand. The goal of a loyalty program is to build customer loyalty and encourage customers to make repeat purchases by rewarding them for their patronage. Here is an example how Super Hair Pieces are using reward program pop-up on their website to incentivize repeat customers and referrals,
Credit: Super Hair Pieces
A well-designed loyalty program can provide customers with a reason to spend more money with your brand than your competitors, as they can unlock rewards and special offers that they can’t find anywhere else.
Why does this work?
A loyalty program increases customer spending, bolsters customer retention, and enhances customer loyalty, all of which are key ingredients to improve customer lifetime value. A loyalty program also offers valuable data about customer behavior, which can be used to tailor your marketing efforts and improve the overall customer experience. This, again, will have a positive impact on the CLV.
Amp up your customer service
Enhancing your customer service can make the customers feel that their needs are being met and their concerns are being addressed, that too in a timely and satisfactory manner. This will encourage them to continue doing business with your company. In other words, it can result in repeat purchases and a longer customer lifetime. Good customer service also helps in reducing customer churn, as a satisfied customer is less likely to switch to a competitor. You can improve your customer service by offering personalized services, omnichannel support, and a seamless return or refund policy.
Why does this work?
Good customer service can make the customers feel valued by your brand. It clearly communicates that customers are more important to you than sales. This results in more repeat purchases and, finally, better CLV.
Encourage cross-selling and up-selling.
Upselling and cross-selling are extremely important for any business because they can help increase the Average Transaction Value (ATV) and the revenue. In addition, cross-selling and upselling also improve the customer’s perception of your business. For example, if a customer buys a pair of shoes from your online store, you can also recommend a pair of socks to go with the shoes, improving the customer’s overall experience with your store.
Why does this work?
When you carefully select and recommend products that are relevant to the customer’s needs and interests, you can build trust. As a result, it improves the customer retention rate and results in a longer customer lifetime.
Keep engaging your customers through email marketing
By sending targeted emails to your customers, you can stay on top of their minds and encourage repeat purchases. For instance, you can send personalized emails with special offers or recommendations based on the customer’s past purchases. This can help increase the overall value of that customer’s relationship with your business.
Why does this work?
By regularly sending emails that are relevant and personalized, you can bring your customers back to restock supplies, check out new products and offers leading to better CLV.
Customer Lifetime Value (CLV) is a key metric to understand and optimize for any business. By calculating the expected value of a customer over their lifetime, you can identify the most valuable customers for your business and focus your efforts on retaining and maximizing the value of these customers. Thereby, building a profitable and successful business.
But we understand improving CLV takes a lot of time and effort and might not be possible for all due to limited resources. And that’s where we come in.
We have worked with more than 200+ brands helping them achieve long-term sustainability by improving the Customer Lifetime Value. To know more about how we can help you improve CLV, book a free consulting session with us today!
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