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How To Calculate Customer Lifetime Value
How To Calculate Customer Lifetime Value
It’s easier to sell to an existing customer than it is to acquire a new one. For this reason, you want to ensure that
your customers are satisfied with your product or service so that you can retain them long enough to recoup the
investment required to earn their business in the first place.
The last thing you want is for customers to churn so that you continue to scramble for new business. One of the
best ways to mitigate this is by measuring customer lifetime value (CLTV). Doing so will help your business acquire
and retain highly valuable customers, which results in more revenue over time.
Customer lifetime value (CLV, or CLTV) is a metric that indicates the total revenue a business can reasonably
expect from a single customer account throughout the business relationship.
The metric considers a customer's revenue value and compares that number to the company's predicted customer
lifespan.
The longer a customer continues to purchase from a company, the greater their lifetime value becomes.
This metric is something that customer support and success teams can directly influence during the customer's
journey. Customer support reps and customer success managers play critical roles in solving problems and
offering recommendations that increase customer loyalty and reduce churn.
It can also be used to make business decisions. For example, you can use customer lifetime value to identify
customer segments that are most valuable to the company and target accordingly.
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The longer the lifecycle or the more value a customer brings during that lifecycle, the more revenue a business
earns. Therefore, tracking and improving CLV results in more revenue.
CLV identifies the specific customers that contribute the most revenue to your business. This allows you to serve
these existing customers with products/services they like and make them happier, resulting in them spending more
money at your company.
According to HubSpot Research, 55% of growing companies think it's "very important" to invest in customer
service programs.
If we look at companies with stagnant or decreasing revenue, only 29% said this investment was "very important."
Companies that are actively geared towards customer success are experiencing more revenue because of
increased customer satisfaction.
2. It can help you identify issues so you can boost customer loyalty and retention.
If you review CLV as a priority in your business, you can identify any worrying trends and come up with action items
to address them.
For example, if you find the CLV to be consistently low, you can work to optimize your customer support strategy or
loyalty program to better meet the needs of your customers.
When you know the lifetime value of a customer, you also know how much money they spend with your business
over some time — whether it's $50, $500, or $5000. Armed with that knowledge, you can develop a customer
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4. Increasing CLV can help reduce customer acquisition costs.
Acquiring new customers can be costly. As noted by a recent article from The European Business Review,
acquisition is typically five times more expensive than retention.
Additionally, another study conducted by Bain & Company found that a 5% increase in retention rate can lead to a
rise in profit between 25% to 95%.
These stats show it’s essential that your business identifies and nurtures the most valuable customers that interact
with your company. By doing so, you'll have higher profit margins, increased customer lifetime values, and
reduced customer acquisition costs.
Now that we understand the importance of customer lifetime value, let’s dive into lifetime value calculation.
Customer Lifetime Value = (Customer Value * Average Customer Lifespan) To find CLTV, you need to
calculate the average purchase value and then multiply that number by the average number of purchases to
determine customer value. Then, once you calculate the average customer lifespan, you can multiply that by
customer value to determine customer lifetime value.
We’ll look at both components of this formula (and how to calculate them) below.
Predictive Customer Lifetime Value
The predictive CLV model forecasts the buying behavior of existing and new customers using regression or
machine learning.
Using the predictive model for customer lifetime value helps you better identify your most valuable customers, the
product or service that brings in the most sales, and how you can improve customer retention.
However, because most customer journeys are not identical, this model has certain drawbacks. Active customers
(deemed valuable by the historical model) might become inactive and skew your data. In contrast, inactive
customers might begin to buy from you again, and you might overlook them because they’ve been labeled
“inactive.”
Read on to learn about the different metrics needed to calculate customer lifetime value and why they’re
important.
As we examine the most common CLV formulas, analyze the variables that contribute to each to better serve your
business needs.
Average Purchase Frequency Rate
Calculate this number by dividing the number of purchases by the number of unique customers who made
purchases during that period.
Customer Value
Calculate this number by multiplying the average purchase value by the average purchase frequency rate.
Customer Lifetime Value Formula
Multiply customer value by the average customer lifespan. The multiplication will give you the revenue you
can reasonably expect an average customer to generate for your company throughout their relationship with
you.
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Once we calculate the average purchase value for one customer, we can repeat the process for the other five. After
that, add each average together, divide that value by the number of customers surveyed (five) to get the average
purchase value.
Once we repeat this calculation for all five customers, we average their values to get the average customer's value
of $24.30.
For Starbucks customers, that value turns out to be $25,272 (52 x 24.30 x 20= 25,272).
The result? You need to stand out while making this straightforward. Use the data customers have provided to offer
curated item selections or great deals, and then follow up with email contacts to make sure what they’ve already
bought lives up to expectations.
Optimized onboarding processes work because they establish a framework for long-term customer relationships
that help increase CLV over time.
When a customer is about to check out, you can offer relevant complementary products to those they’re about to
buy. Brands like Amazon and McDonald’s are examples of companies that use the upsell and cross-sell method
extremely well. Amazon will offer you related products and bundle them into a group price as depicted below.
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McDonald’s, meanwhile, offers small add-ons — such as those delicious apple pies — that help boost overall CLV.
If you’re a subscription-based company, you can increase your average order and customer lifetime value by
encouraging your customers to switch to an annual billing cycle.
This works because even a small increase in order value over time leads to increased CLV and overall revenue.
Consider the example of the McDonald’s apple pie. While adding a $1(ish) item to each transaction isn’t much on
its own, over time these smaller amounts add up to substantive revenue and help increase total CLV.
As a result, it’s critical to engage with customers on your social media accounts with more than just canned
advertising posts. For example, your teams could start a back-and-forth conversation about something that
interests your target customer base, or you could do some social sleuthing to discover more about your customers
and then send them a (small) free gift that aligns with their interests.
This works because you need to stand out from the crowd. Quick and easy eCommerce is now par for the course —
if you can forge an actual connection with customers you’ll keep them coming back and increase your total CLV.
Sometimes it’s better to listen than talk. Customers often have good advice on how you could improve business
practices to better serve their needs — and you can increase CLV by taking it.
For example, you could create a poll on new product or service ideas and see what your customer base thinks.
Make sure you don’t lock them into a specific set of choices; give them room to add their own ideas that could help
make things better. While not every customer will participate, those that do will often have good advice and can
end up being some of your most loyal customers.
Quick tip: Give credit where credit is due. If a customer comes up with a good idea, credit them for the help and
consider sending them something as a token of appreciation.
This works because it shows you’re willing to listen. Too many brands take the stance that they know what their
customers want better than customers themselves, which in turn can lower total CLV. By taking the time to listen
and respond — even if customer advice isn’t exactly what you want to hear — you can facilitate long-term loyalty and
boost CLV.
Active social media is one example. By equipping a customer success team with the tools and technology to
monitor and respond to customer comments or concerns via social media, brands can jumpstart the connection
process and help customers feel heard.
CLV is now driven by relationships and relationships require an ongoing connection. While one-hour email
response times may be out of reach, the easier you make it for customers to connect with your brand the more
connected they’ll feel overall and the more likely they’ll come back to spend more money.
You can improve your customer service by offering existing customers personalized services, omnichannel
customer support, and a proper return or refund policy.
It’s simple: The better your customer service the more customers feel valued by your brand for more than their
purchases. If you stand behind your products with substantive return and refund policies, it communicates to
customers that your priority is quality and satisfaction, not overall sales volume. The result? Increased CLV.
Customer lifetime value is an incredibly useful metric. It tells you which customers spend the most at your business
and which ones will remain loyal to you for the longest amount of time. Use the formulas and model provided
above and start calculating CLTV for your business today.
Editor's note: This post was originally published in May 2021 and has been updated for comprehensiveness.
Originally published Apr 1, 2022 7:00:00 AM, updated April 01 2022
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