Customer Lifetime Value: What It Is, and How to Calculate It

From repeat purchase rate to average order value, there are many metrics to keep up with as a marketer. But if there were a marketing metric competition bracket (think “Marketing March Madness”), we’re pretty confident that customer lifetime value (CLV) would make it pretty far in the tournament — possibly to the championship. 

CLV measures a customer’s value to your company. By knowing who your most valuable customers are, you can analyze their characteristics to find more like them or, more importantly, to encourage those customers to buy more.

According to recent statistics, there’s a 5–20 percent probability that you’ll sell your service or product to a new customer, whereas the chance of selling it to an existing customer is around 60-70 percent. So successful marketers don’t focus solely on strategies and techniques for acquiring new customers. They also develop tactics to retain profitable customers and stimulate them to buy more. 

And that’s because the more profitable your customers, the less money you have to spend to increase sales. And the less money you spend to increase sales, the more money you make. 

But what exactly is customer lifetime value, and how is it calculated?

What is Customer Lifetime Value? 

Customer lifetime value (CLV or LTV) is the total profit a customer has brought to your business during your relationship with them. It helps you predict future revenue, measure long-term business success and estimate how much you should invest in retaining a customer. 

CLV is a snapshot of a customer’s value to your company at the time of calculation. As time goes on and both parties spend more money, that value will change. But you can make future predictions based on past data.

Understanding the lifetime value of a customer allows you to answer these questions:

  • What future revenue can you predict?
  • How much can your brand afford to spend on marketing and sales?
  • How much money should you invest in customer retention?
  • How can you optimize acquisition cost for max value?

How to Calculate Customer Lifetime Value 

Now that you understand how vital CLV is to revenue growth, let’s discuss how you can calculate it. 

First, calculate the value of your average sale, the average number of transactions, and the duration of your business relationship with a given customer. 

Next, calculate the lifetime value by multiplying the average value of a sale, the average number of transactions, and lastly, the average customer retention period. 

Because you calculate a customer’s lifetime value in gross revenue terms, you’ll need to multiply it by your profit margin to get the true customer lifetime value.  

Customer Lifetime Value = Average Value of Sale x Number of Transactions x Retention Time Period x Profit Margin

Or simply:

Customer Lifetime Value = Lifetime Value x Profit Margin

Real-Life Customer Lifetime Value Example 

For a quick example, let’s calculate the customer lifetime value of a hypothetical online clothing retailer. 

The average sale this online clothing retailer makes to this customer is $50. The customer purchases from the retailer three times per year for two years. So the lifetime value of this specific customer is calculated as follows:

  • Lifetime value = $50 x 3 x 2 = $300

After calculating the cost of goods or COGS, marketing, overhead, and all other administrative expenses, the online clothing retailer’s profit margin is 20%

  • Customer Lifetime Value = $50 x 3 x 2 x 20%

= $300 x 20%

= $60

This simple calculation reveals that a specific customer’s lifetime value for this hypothetical online clothing retailer is $60 — much less than the lifetime value calculated above. Retailers can use this to project cash flow and understand how many new customers they must acquire and retain to reach desired profitability. 

Why Should I Care About CLV? 

CLV determines the financial value of each of your customers. In and of itself, that’s an important reason to care about Customer Lifetime Value. However, CLV is also unique in that it can look forward. Customer profitability, on the other hand, measures past activities to gain insights. CLV can forecast future activity to increase revenue generation and improve your bottom line. 

Here are some of the advantages of understanding Customer Lifetime Value: 

  • CLV allows you to measure the financial impact of your marketing campaigns, initiatives, and other activities. 
  • It can also change how your brand thinks about marketing in relation to creating loyalty objectives or focusing spend on underutilized areas. 
  • CLV can help you find balance in terms of long-term and short-term marketing goals and develop a much better understanding of which investments produce the highest return. 
  • It encourages better decision-making by teaching marketers to spend less time acquiring customers of a lower value. 
  • Understanding CLV leads to effective management of your customer relationship — which ultimately leads to increased profitability. 

How To Improve CLV 

  1. Create a Loyalty Program

Loyalty programs incentivize customers to make repeat purchases. The accrual of “points” itself is satisfying, and studies show that customers tend to spend more than they would otherwise when they have a coupon or discount.  So incentivize repeat purchases, and you will automatically increase your customer retention along with the lifetime value of your customers.

  1. Improve Customer Relationship Management

Offering quality customer service and a consistent positive user experience will keep your customers satisfied and lengthen your average customer lifespan. It will also give you insight into what needs improving and where you can cross and upsell, further boosting your CLV. 

  1. Target Your Most Valuable Customer Type

When you calculate your current Customer Lifetime Value, you can quickly identify your best and most profitable customer type and use that crucial information to improve your CLV moving forward. Refine your marketing campaigns to target those high-value customers who are more likely to make repeatedly larger purchases throughout their lifespan. 

A Final Word 

CLV is one of the most important metrics marketers can track to gain insight into the effectiveness of their campaigns and spend. It can also indicate areas of improvement to the product team and help the finance department project future performance.

To track CLV and gain insight into your most valuable customers, you need a behavioral analytics tool like Kissmetrics. Our reports will show you which customers are the most valuable, the products they bought and the features they used, and the marketing campaigns that drew them in so you can increase revenue, reduce churn, and gain greater insight into what your customers need.

Schedule a demo with us today and see the power of data.

 

Sources:

https://www.researchgate.net/publication/228302768_Customer_Lifetime_Value

https://www.forbes.com./sites/patrickhull/2013/12/06/tools-for-entrepreneurs-to-retain-clients/

https://www.investopedia.com/terms/o/operating_expense.asp

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