In this article, we will look at the meaning of Customer Lifetime value and understand how to calculate it.
Customer Lifetime Value
What is Customer Lifetime Value? Customer Lifetime Value (CLV) is a general measure of how valuable a customer is to your business. This measure cares about the entire customer-business relationship from beginning to present. In the Start Your Business in 30 Days program, you will learn how to calculate your customer lifetime value and other important business metrics.
Why Is The Customer Lifetime Value Important?
Why would you care about this value in the first place? The short answer is that it is easier to keep an existing customer than to acquire a brand-new one. Therefore, maintaining and increasing the value of the customers you already have is great for your business. Luckily for you, you are in the perfect place to learn about how to measure CLV.
By calculating the customer lifetime value (CLV) of a client, you are able to think up new strategies and products that will continue to engage the client’s interest and attract new customers.
If you’ve been running your business a while and have developed a multi-year relationship with a customer, the CLV is a great metric to keep track of the relationship. It tells you how much revenue you can expect one customer to bring during the course of the relationship. It also makes it easier to know if a customer is going to “churn” i.e. stop patronising your business as time goes on. The longer a customer continues to buy your products, the greater their CLV becomes.
Here’s a good example of how using the CLV value has maximised a company’s profits. Netflix, the billion-dollar online streaming service, used the CLV to increase their overall profits by a huge margin. In 2007, Netflix was a DVD rental company. However, in that same year, they figured out that most of their customers stayed with them for an average of 25 months. They also measured an average CLV of only $291.25. This led them to conclude (correctly) that most people didn’t like waiting for DVDs to be sent to them by mail. Therefore, Netflix decided to implement the online-streaming model many of us know today. In doing so, they increased their customer retention rate by up to 4%, which you’ll see later is a huge improvement.
How To Calculate Customer Lifetime Value
Now, how do you calculate this CLV we’ve been telling you so much about? See the 5 steps below.
Step 1 – Find Average Purchase Value (APV): Calculate APV by dividing your business’s total revenue over a year by the number of purchases over that year.
APV = Total Revenue/ No. Purchases
Step 2 – Find Average Purchase Frequency Rate (APFR): Find the APFR by dividing the number of purchases by the number of unique buyers over the same year.
APFR = No. Purchases/No. Unique Buyers
Step 3 – Find the Customer Value (CV): Note that this is not CLV! Calculate CV by multiplying the APV by the APFR.
CV = APV x APFR
Step 4 – Find the Average Customer Lifespan (ACL): Calculate this number by finding the average number of years a customer continues to patronise your business. This was “25 years” from the Netflix example above.
ACL = Sum of all Customers’ Lifespan/No. Customers
Step 5 – Find the CLV: The final step! You calculate CLV by multiplying the customer value (CV) by the average customer lifespan (ACL). This number is the revenue you can expect a single customer to generate for your business during your relationship.
CLV = CV x ACL
How To Interpret the CLV
Okay, you’ve calculated the customer lifetime value for your business. Great! But how do you interpret this number? One way to do this is by comparing this CLV to the average customer acquisition costs. The customer acquisition cost is how much money and time you spend on marketing to attract new customers.
If the CLV is greater than the cost of acquisition (COA), this is probably good news for your business. It means you have customers who keep coming back and who spend a reasonably long time with your company.
However, it’s worth noting that your gross margin still plays a part in how you interpret your CLV. Gross margin is the difference between the total cost of production and revenue, all divided by total revenue. If you observe that the cost of production is only a tiny part of your total costs e.g. 9%, you might want to increase the amount you spend on advertising and marketing. Your business should grow, after all.
On the other hand, if CLV is equal to the COA, you are spending the same amount of money to get a customer as you are gaining from that customer. This might not be a bad thing if your business is just starting out, and you’re trying to attract new customers. However, you might want to take it as a warning that your marketing isn’t working as it should.
How To Improve Customer Lifetime Value
So, how can you improve your company’s CLV? It boils down to two things: customer retention and customer satisfaction.
According to a study done by Bain & Company, a 5% increase in your customer retention rate can lead to a total profit increase between 25% and 95%. Add this to the fact that, it’s more expensive to acquire new customers than it is to retain the ones you already have. The take away is that you must identify the customers who are most valuable to your company and nurture them. Your revenue increases and so does your CLV.
If you have not put a lot of effort into customer service, you should. Apart from the fact that it’s good to treat others well, good customer service has a very strong influence on customer loyalty and CLV. Customer service managers, by being as helpful as they can and solving problems play a big role in how many customers you retain. A satisfied customer comes back, and your CLV will thank you for it.
The customer lifetime value (CLV) is a very important metric for any business. Just studying this number can give insight into how long customers stay in a relationship with your business, how good your customer retention rate is and if you ought to spend more money to increase your customer base.
How will you make use of the CLV in your business? Let us know in the comments below.
If you would like to start your business in 30 days, enrol into our program Start Your Business in 30 Days and you will move from idea to starting your business in 30 days. During the program, we will dive deep into understanding your Customer Lifetime Value and other important business metrics.
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