The first time you hear about it, customer lifetime value (also abbreviated as CLV, CLTV, LCV, or LTV marketing) might not come across as a vital metric. Failure to calculate, however, can put your brand lightyears behind your competitors. CLV enables brands to understand how they fare with their audience, how much their customers appreciate their offerings, and what they are doing right.
As a business owner, you would want to get your hands on this type of information. If you think calculating customer lifetime value would require Harvard-level mathematical skills, it doesn’t. So, if that’s the reason you’re shying away from calculating this essential metric, let me tell you how easy it is. Successful marketers calculate this metric time and again to establish map points at every stage of their business.
What Is Customer Lifetime Value (CLV)?
The average amount of money that customers spend on business over the entire relationship period is known as customer lifetime value.
It represents a customer’s value over a particular duration to a company to put it in simpler terms. It is the total worth of a customer to a business over the entirety of their relationship. It considers a consumer’s revenue value by comparing it with the company’s predicted customer lifespan.
As a metric, it is used to identify consumer segments that are most valuable to the company and allow companies to increase their existing customers’ value, which is a great way to drive growth as it is more expensive to acquire new customers rather than retaining existing ones. A simple example of customer lifetime value would be when a customer buys products from a company for 5 years, with an expenditure of $20 per year, the customer lifetime value is said to be $100.
How to Calculate Customer Lifetime Value (CLV)?
The example given above was for a basic understanding of customer lifetime value. To calculate it is another ball game altogether.
There are several different methods to calculate CLV. It can either be historic for predictive. Historic CLV relates to actual purchases over the years, and predictive CLV refers to predicting what your customers will spend. It is easier for businesses that run on subscription models to calculate their clv than e-commerce businesses because sales are more predictive in the former.
From the popular methods of calculating CLV, there is one that stood out from the rest. This method makes use of four crucial KPIs to determine LTV.
Average Order Value (AOV)
Purchase Frequency (F)
Gross Margin (GM)
Churn Rate (CR)
Each of these KPIs contribute to total profit; therefore, finding out which needs most work for profit maximization is essential. The formula is as follows.
CLV = AOV*F*GM*(1/CR)
How to Calculate Average Order Value (AOV)
AOV = Total Sales Revenue / Total Number of Orders
Example:
Total Sales Revenue = $10,00,000
Total Number of Orders = 50,000
AOV = 10,00,000 / 50,000
Average Order Value = $20
How to Calculate Purchase Frequency
F = Total Number of Orders / Total Number of Unique Customers
Example:
Total Number of Orders = 50,000
Total Number of Unique Customers (annually) = 20,000
F = 50,000 / 20,000
Purchase Frequency = 2.5
How to Calculate Gross Margin (GM)
GM = Total Sales Revenue – Cost of Goods Sold / Total Sales
(Cost of Goods Sold (COGS) = Beginning Inventory + Additional Purchases During Period Cost – Ending Inventory
Example:
Beginning Inventory = $2,00,000
Additional Purchases = $5,00,000
Ending Inventory = $1,50,000
COGS = 2,00,000 + 5,00,000 – 1,50,000
Cost of Goods Sold = $5,50,000)
Example:
Total Sales Revenue = $9,00,000
Cost of Goods Sold = $5,50,000
GM = 9,00,000 – 5,50,000 / 9,00,000
Gross Margin = 0.38 or 38%
How to Calculate Churn Rate (CR)
CR = Number of Customers at the End of a Time Period – Number of Customers at the Beginning of Time Period / Number of Customers at the Beginning of Time Period
Also, Customer Lifetime Period = 1/Churn Rate
Customer Lifetime Value = AOV * F * GM * (1/CR)
Example Using the Above Values:
AOV = $20
F = 2.5
GM = 0.38
CR = 55% or 1/1.82
CLV = 20 * 2.5 * 0.38 * (1/1.82)
Customer Lifetime Value = $34.5 per customer
How to Increase Customer Lifetime Value?
Now that you know how CLV is calculated, it is time to make improvements in your process. Follow the steps mentioned below to boost CLV and retain more customers.
- Segment Customers
You may want to segment your customers into lists depending on where they are in the sales funnel and their preferences and interests. This allows brands to prepare specific communication for each segmented list. Upon segmenting these existing customers and prospects, you can use drip marketing to nurture them and build meaningful relationships.
- Utilize the Freemium Model
Freemium models are one of the best ways to increase customer lifetime value. An example of this would be in-app purchases. This model gets people to try the product; they like it and decide to spend money on it, thereby increasing customer lifetime value. An excellent example of this would be the LinkedIn premium, which provides analytics and other features and the available offerings in exchange for a subscription fee.
Discounts and Coupons
Everybody likes receiving coupons that provide discounts. The only thing brands need to worry about is the timing of the coupon. To increase customer lifetime value, provide customers with coupons a few weeks after making a purchase, or at the time of sale but for a later period. Since the customer has already made a purchase, they will be more likely to return to your website or store looking for other products.
- Harness Social Media
Existing customers may already be following your brand’s social media pages. Keep in touch with customers via the social media platforms they prefer and include CTAs to redirect them to your website. This can also be done by purchasing ad spaces on social media platforms and enticing audiences to make a purchase.
- Website Experience
Often, people refrain from purchasing products due to problems encountered during the buying process. Organizations must focus on reducing website load time, which could be done by making their website mobile-friendly and using technologies such as accelerated mobile pages (AMPs). Offer a variety of payment options, and shipping details, among other solutions.
Keep a Check on Customer Costs
While customer lifetime value is a helpful metric that allows businesses to track and optimize their processes, it is essential not to focus solely on this one metric. It is vital to keep a close eye on the cost of customers to your business. This can be termed as Cost to Serve. While some companies might record a customer lifetime value metric, it is essential to keep the cost of serving an existing customer in check.
If the cost of serving a customer is too high, businesses might be facing a loss despite their high CLV. Getting a good understanding of these metrics and simultaneously tracking them over time is the only way of knowing what drives customer spend and loyalty and what adds two business revenue.
Conclusion
In today’s ultra-competitive markets, customer lifetime value matters more than before. It directly impacts retention rates, identifies non-performing KPIs, reveals brand loyalty, and helps businesses maintain and improve their market position. Businesses do not stress enough on retaining customers as much as they work to acquire new ones. With countless studies and their results that show the importance of retention, it is high time this changed.
