How To Calculate Customer Lifetime Value

 What is customer lifetime value, and how to calculate it?

You’ve come to the right place.

This article will define, explain the importance, and show you how to calculate customer lifetime value. We’ll also give you case studies of brands that use CLV successfully.

Come with us.

What is Customer Lifetime Value (CLV)? 

This is the total revenue a business expects to earn from the average customer over its relationship with the business. This metric helps you gauge how profitable or otherwise a customer or customer segment is throughout their relationship with your brand.

Why is Customer Lifetime Value Important?

The following reasons why considering Customer lifetime value (CLV) is important:

  • It helps identify and target high-value customers: By knowing your customers’ lifetime value, you’ll also know the amount they will spend on your business over time. This information is crucial as it can help you develop a customer acquisition strategy that targets customers who will bring the most value to your business.
  • Minimize customer acquisition costs: It’s no secret that the cost of acquiring a new customer is much higher than the cost of retaining one. Thus, your business must recognize and nurture the most valuable customers that engage with your brand. This helps you achieve higher profit margins and customer lifetime values and lowers customer acquisition costs.
  • Increased revenues: CLV helps you pinpoint customers who bring in the most money for your company. This, in turn, helps you offer these existing customers goods and services they enjoy, which will make them happier and encourage them to spend more money with your business, boosting your profits.
  • Enhance customer retention and loyalty: Prioritizing CLV and regularly reviewing it can help you identify your retention strategies and develop specific actions to address those issues. This will, in turn, improve your customer retention and loyalty.

Customer Lifetime Value Model 

There are 3 models you can use to calculate customer lifetime value:

Historical approach

This method uses historical data to estimate a customer’s value without considering whether or not an existing customer would stay with the business. Under this, the average order value is utilized to estimate the value of the customers.

While this approach makes a lot of sense if most of your customers only engage with your business over a certain period, it has some limitations. For instance, customers who were once considered active and valued by the historical model can become inactive. This means that the data you’ll get will be biased. Additionally, you might miss out on inactive customers if they start making purchases from you again.

Predictive approach

This model seeks to simulate a customer’s transactional behavior and forecast their expected future actions. The method uses regression or machine learning to predict the buying behavior of existing and current customers. In addition to previous purchases, this strategy takes customer behavior into account.

This method allows you to accurately identify your most valuable customers, the product or service that generates the most revenue, and the best ways to increase customer retention.

Since it uses algorithms to forecast the total value of customers, it’s more accurate than the historical customer lifetime value model.

Traditional approach

Growth in the business world is not linear. Your sales per customer may change from one period to another. So, what will you do if you need to consider the changes that take place throughout a customer’s lifetime? In this case, you’ll need a more detailed CLV formula that accounts for margins, inflation, and retention rate and provides a more complex view of how CLV changes over time. And that’s where the traditional model comes in.

This method uses the gross margin per lifespan, retention rate per month, and discount rate per month to calculate customer lifetime value (CLV).

Customer Lifetime Value Formulas 

Your customers are unlikely to spend the same amount at your business or shop at the same frequency. You’ll need to know the average purchase price, the average purchase frequency, and the lifespan or average length of time customers shop at your business to calculate the customer lifetime value. The following are the basic formulas you’ll use:

Average Purchase Value

This is the value of all customer purchases over a specific timeframe, usually a year, divided by the number of all purchases throughout the same period.

Average purchase value = Total revenue/Total number of purchases.

Average Purchase Frequency Rate

To obtain this, you’ll need to divide the number of purchases in the same period by the number of unique customers who purchased during that period. If a customer made more than a single purchase, you count them only once.

Average Purchase Frequency Rate = Number of purchases/number of unique customers.

Customer Value

This is the average purchase value multiplied by the average purchase frequency rate.

Customer Value = Average purchase* Average purchase frequency

Average Customer Lifespan

The average customer lifespan is the average length of time a customer continues purchasing from your business.

Average Customer Lifespan: Total customer Lifespans/ number of customers.

Customer Lifetime Value Formula 

The customer lifetime value is an important metric showing how much you can reasonably expect a customer to spend with your business over their lifetime. This can help you improve customer retention and optimize customer acquisition strategy.

To find customer lifetime value, you’ll need to calculate the average purchase value and then multiply the resulting figure by the average number of purchases to determine customer value. Next, you should calculate the average customer lifespan and multiply that by the customer value to obtain the customer lifetime value.

Simply put, Customer Lifetime Value = (Customer Value* Average customer lifespan).

Where: 

Customer value=Average purchase value* The Average number of purchases

The following is a practical example to help you better understand this:

Example

Consider a business whose revenue for one year was $100,000 and had 400 unique customers in that period who made 500 purchases. The average customer lifespan is estimated to be 10 years.

Calculate the average purchase value.

The first step is to find the average purchase value given by = The value of all customer purchases over a period/ number of purchases in that period.

Therefore, for a single customer, the average purchase value=10000/500

 =$ 200. Therefore the average purchase value for the company is $200

Calculate the average purchase frequency rate. 

Next, you’ll need to find the average purchase frequency rate by dividing the purchases by the number of unique customers. Using the above example;

Average purchase frequency = 500/400

Average purchase frequency is 1.25

Calculate the average customer’s value. 

The next step is to determine the average customer value. This is calculated by multiplying the average purchase value by the average purchase frequency.

In our example: Average customer value=Average Purchase value* Average purchase frequency

200* 1.25=250

Calculate the average customer’s lifetime span. 

After calculating the average customer value, you’ll need to determine the average customer lifetime span. This is calculated by dividing the total customer lifespan by the number of customers. In our example, this is estimated to be 10 years.

Calculate your customer’s lifetime value. 

Calculating the customer’s lifetime value is the final step. To get this, multiply average customer value by the average customer lifespan.

Hence, CLV = Average customer value * average customer lifespan

 CLV=250*10

CLV=2500

CLV Case Studies 

The following are examples of brands that have successfully utilized CLV to their advantage and realized significant benefits.

  • Netflix: This brand learned that a typical subscriber stayed with the brand for an average of 25 months. After calculations, the company found its CLV to be $291.25. With this information, Netflix was able to realize that viewers were impatient. As a result, the company decided to implement online streaming after analyzing the available data. This strategy was aimed at keeping the members satisfied as they waited for new DVDs in the mail. Consequently, the brand was able to improve retention by 4%. 
  • Starbucks: This coffee brand has shown that companies can increase customer lifetime value and boost revenues by improving customer satisfaction. The brand spends less than $ 14,099 on acquisition.
  • Amazon: Based on the estimations given by Consumer Intelligence Research Partners, Amazon Prime members spend approximately $1340 per year on Amazon, equivalent to two times what non-prime members spend. Guided by this metric, Amazon decided to focus and invest more in the prime members, which increased the company’s profits over four years.

These 3 brands prove that working on your customer’s lifetime value can propel your business to growth and success.

Customer Lifetime Value Contributing Factors 

Various factors impact customer lifetime value. These include

  • Brand loyalty: Any business must cultivate a sense of brand loyalty in its customers, as this translates to higher customer retention rates and lower churn rates. Customers dedicated to a brand can act as the brand’s ambassadors and market it via word of mouth. Generally, the stronger the brand loyalty, the higher the customer lifetime value a business will obtain.
  • Scalable sales and marketing: How adaptable are your marketing strategies? It’s important to ensure that the marketing strategies you put in place can be changed or expanded to suit the current situation. If your company’s revenue growth is directly tied to its sales and marketing costs, it’s important to maximize those efforts. This is because if the revenues decline but the marketing costs keep rising, they will eat into the profits.
  • Churn rate: Also known as the attrition rate, this refers to the percentage of customers that stop doing business with you. This rate differs from one business to another based on the competitive advantage that a business has. Generally, the higher the churn rate, the lower the customer lifetime value, and vice versa.

Tips to Increase Customer Lifetime Value

The following tips can help you increase customer lifetime value for your business:

  • Implement a loyalty program: Coming up with a loyalty program can help you offer more personalized services to your customers and encourage repeat sales. Rewarding your loyal customers will make them feel valued and enhance brand loyalty. This will, in turn, enhance customer satisfaction, improve retention rates, and consequently increase your customer lifetime value.
  • Optimize your customer service: Offering better customer service will result in higher customer satisfaction and better customer experience, improving your retention rate and increasing your customer lifetime value.
  • Listen to your customers: Give your customers a way to share their feedback, as this will make them feel important. Listen and make attempts to satisfactorily address any complaints. This will allow you to know where you are falling short and make steps to improve. If customers feel valued, they are likely to remain loyal to your brand, which boosts your customer lifetime value.
  • Retargeting: Re-engaging customers who have had a previous experience with your brand can help to boost your customer lifetime value. This can help improve brand recognition by serving as a simple reminder of the business.

How to use your CLV calculations 

Here are some of the ways you can utilize your CLV calculations for your business:

  • Minimize churn and boost loyalty: You can use CLV to identify the high-value customers you should nurture and reward to prevent them from switching to your competitors.
  • Come up with new experiences that spur your business to grow: CLV will help you identify positive and negative experiences that impact your business. This will help you develop better strategies for better experiences to boost your business growth.
  • Optimize your marketing efforts: CLV will help you identify your most valuable customers allowing you to prioritize your customer acquisition methods and allocate resources where they will be most effective.

Key Takeaway 

The cost of acquiring new customers is very high compared to retaining existing ones. That is why any business needs to ensure it builds brand loyalty and improves customer retention. Customer lifetime value is important as it will help you identify your most valuable customers and develop effective strategies to ensure they stick with you. This will not only increase your retention rate but also boost your revenues.

To ensure the success of your business, you’ll need to regularly review your customer lifetime value and take steps to increase it. Well, we’ve given you everything you need to know about it. Take this step and sour your business to grow.