Why and How you Should Calculate Customer Lifetime Value

by Henri Gisclard-Biondi, on 1/21/21
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The Customer Lifetime Value (CLV) is one of the key metrics to consider when defining your marketing strategy. It reflects the quality of the customer relationship you have with your clients.

Whether you are a large or small business, and regardless of your activity sector, it is a precious tool. It helps you define your most valuable market segments.

You will need it to take decisions with the best return on investment.

After reading this guide, you will be able to calculate your CLV with two methods. We will also provide ways to improve your CLV so your business can thrive!

What is Customer Lifetime Value?

Definition

Customer Lifetime Value (CLV) is one of the key business metrics used by marketing teams.

It is used to estimate the profit made at each step of the customer journey, from the first to the last.

Businesses have different ways of measuring customer lifetime value. It can be determined in terms of either revenue or profit.

CLV requires basic intermediate steps such as:

  • calculating retention rate
  • calculating the average client lifecycle
  • calculating average purchase value
  • calculating the average purchase frequency rate
  • calculating customer acquisition cost

Why calculate and use CLV

Calculating CLV is a useful key performance indicator for marketing teams working on customer acquisition and retention. Other stakeholders could be interested within the company.

This performance metric can be used by:

  • the commercial team
  • the marketing team
  • the product team
  • the customer service team

Their objectives could be to:

  • calculate the ROI of marketing strategies
  • estimate the maximum customer acquisition cost
  • know which customer segments bring the highest value to the business
  • define actions to reduce attrition

How to calculate CLV in revenue

Intermediate calculations

Calculating CLV requires that you compute other metrics first. While this may seem like a lengthy process, it is quite straightforward. Moreover, these intermediate indicators are also precious KPIs themselves.

Retention rate

To evaluate the client lifetime span or the client lifecycle, you will first need to calculate the retention rate. It is the proportion of clients you still currently have relative to the total number of customers you’ve had over the relevant period.

Retention Rate = Number of clients left/Total number of clients for the period

☝️  Retention rate is the opposite of churn rate or attrition rate, which is the proportion of customers lost for the period. It is calculated by dividing the number of leaving customers by the total number of clients.

Average customer lifespan

This value represents the average duration of your customer lifecycle. This represents the average length of time a customer keeps doing business with you.

Average Customer Lifespan = 1 / (1 - Retention Rate)

Average purchase value

Your revenue divided by the number of orders represents how much an average order is worth to your business.

Average Purchase Value = Revenue / Number of orders

Average purchase frequency rate

The result represents the average number of orders made by a client. It is simply the number of orders divided by the number of clients.

Average Purchase Frequency Rate = Number of orders / Number of clients

Calculating CLV in revenue

The Customer Lifetime Value is calculated by multiplying the average purchase value by the average purchase frequency rate, then multiplying the result by the average customer lifespan.

With this formula, you can calculate the CLV in revenue.

CLV in Revenue = (average purchase value * average purchase frequency rate) * average customer lifespan

How to calculate CLV in profit

Intermediate calculations

Cost of customer acquisition

This value represents how much you spend on average to acquire a customer. It is calculated by dividing the cost of acquisition by the number of customers the marketing campaign(s) brought in.

Cost of customer acquisiton = acquisition marketing costs / new customers brought in

Cost of customer retention

This value should give you an idea of how much you spend to keep your customers returning. It is the result of the division of your retention marketing costs by the number of customers you have.

Cost of customer retention = Retention marketing costs / Number of clients

Calculating CLV in profit

This formula will give you the CLV in terms of profit, meaning how much profit a customer brings to your company over the time spent doing business with you. Note that you need to calculate the CLV in revenue first.

CLV in Profit = CLV in revenue - (total marketing costs * average customer lifespan)

The best tools to calculate and track CLV

Maybe you don’t have time to collect data, or numbers aren’t your cup of tea. Calculating CLV can be made easier by CRM tools. These can compute your CLV automatically.

Other important metrics can help you understand your customer base and improve customer experience. CRM tools can also generate dashboards which help tracking your customer relationship efforts in real time!

How to improve your Customer Lifetime Value

If CLV is negative, that means your customers cost more than they buy. You can try to improve in the following areas to remedy this problem.

Increase the average purchase value

Making this value increase means your business will get more revenue from each order made. This means each customer will bring in more revenue, therefore increasing the return on investment of your marketing campaigns.

You can increase the average purchase value with techniques such as cross selling or up selling.

  • Cross selling means trying to sell additional products or services with one purchase. In ecommerce terms, this is the “You might also like…” section.
  • Up selling is suggesting a more upscale product. Think of salespeople trying to sell the latest phone to a grandma for example.

Increase purchase frequency

You could entice your customers to make more frequent purchases. Purchase frequency can be increased by the following methods:

  • Make regular promotional offers
  • Create a loyalty program to encourage customers to buy from you

Reduce your marketing budget

Your marketing budget could be cut while maintaining the same results thanks to marketing automation. These tools can:

  • Send automatic emails at key touchpoints of the funnel to improve your conversion rate
  • Create engaging landing pages to direct your customers to an engaging product description

Focus on your retention rate

Increase customer lifespan by focusing on retaining customers. Converting leads is important but creating long term customers can go a long way. Your existing customers need attention too.

  • Use efficient CRM tools to develop a relationship with recurring customers
  • Run retargeting campaigns. Google Ads and Analytics include tools to help you reach out to leads who have left at the checkout page, for example.

Review your marketing segmentation

A good understanding of your customer base can be of great help. Define the different groups of people who buy your products. Build a persona based on their needs, revenue, age...

With a good market segmentation, you can focus your efforts on the most valuable segments. High value customers are the most important to your business, concentrate your efforts on increasing their loyalty to your business.

Summing up

Customer Lifetime Value is an important metric. It can be a great indicator to drive important business decisions. Even though it is mostly used by marketing teams, it can have an impact on wide areas of your business.

The intermediate values required for customer lifetime value calculation are all key business metrics. You should strive to find ways to improve each of them.

Customer Lifetime Value is one of the best ways to measure customer satisfaction, and happy customers are essential to a healthy business!