When you start with customer lifetime value, you will see that it's very simple and affordable to sell your products to an existing client than to acquire a new one. This might help achieve your business goals faster while focusing on providing value to the customers with the highest loyalty and the highest lifetime value.
In this post, we will see what CLV is, how you can calculate yours, and how you can improve the relationship you have with your valuable customers so you can grow your business.
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What Is CLV (Customer Lifetime Value)?
Customer lifetime value or CLV is defined as the amount of money a customer is indicated to spend on your services for the duration of your relationship with that individual. The way you approach it can define your business and vary depending on what you're trying to get from your business.
CLV is more than an exchange of goods for money. It's a measurement of how valuable a customer is to your business over time. Though not all customers can be valued equally, it's less costly to keep the existing customers than to find new ones. By keeping your CLV high, you ensure the success of your business and a higher CLV means that you have more loyal customers.
For example, if one of your customer's CLV is $70k and you need to spend around $5k/year to provide services to this customer, and acquiring a customer like this costs $10k, how long do you want to keep this customer? The answer will be less than 4 years. Otherwise, you will start to lose money.
How to Calculate Customer Lifetime Value
You can calculate CLV with the following steps:
- Predict a customer lifecycle with your business
- Calculate future products purchased to forecast future revenues
- Estimate the costs associated with manufacturing and delivering future products
- Calculate the current value of those revenue amounts
Though the process seems daunting, breaking it down into further steps will make it easier.
A Step by Step Guide to Calculating Customer Lifetime Value
To calculate CLV, you will have to understand a few things:
- Average purchase value: Divide your company's total revenue in a time period by the number of purchases in that same period.
- Average purchase frequency rate: Represents the average amount of orders from each customer.
- Customer value: You can determine customer value by multiplying your first two calculations: average purchase and average purchase frequency.
- Customer lifespan: Defined as the length of time a customer relationship generally lasts before that customer freers themselves from their business.
- Forecast revenue: With the help of the first four steps, you can estimate the revenue from an average customer. Just multiply the customer value by the average customer lifespan.
For example, a Starbucks case study from Neil Patel Digital: “It’s no secret that Starbucks’ acquisition strategy is closely scrutinised and routinely copied. Using rough sales figures from 2004, we’re able to estimate the CLV of an average Starbucks customer.”
CLV can be calculated by:
CLV = Average Order Value (AOV) x Purchase Frequency (PF) x Customer Lifespan (over a period of time)
By focusing on how to increase every element of the equation, you would increase CLV.
Let's take an example: a customer buys a product from your brand for five years (customer lifespan), spends $10 with every checkout (average order value), and buys 5x a year (purchase frequency). The customer’s lifetime value = $250, minus the money you spent to acquire the said customer.
$10 (AOV) x 5 (PF) x 5 (lifespan) = $250
AOV = Average Order Value (AOV)
Purchase Frequency (PF)
Now, you spent $1,000 on paid advertising to get this customer and 49 others (50 total, $20 per customer). Since your calculated CLV totals $250, you spent $1,000 to acquire 50 new clients who spent $11,500 on your products and services.
- Cost of paid advertising = $1,000
- Customers acquired = 50
- Cost per customer acquisition = $20
- Customer Lifetime Value = $250
- Average Order Value = $10
- Purchase Frequency = 5
- Lifespan = 5 years
Why Is Customer Lifetime Value Important to Your Business
According to Forbes, "a 5% increase in customer retention can increase a company’s profitability by 25% to 95%." You can see an increase in profits if you focus on making strong relationships with your customers. This also positively affects customer loyalty and CLV.
The customer lifetime value determines the financial value of each of your customers. That's an important purpose, but CLV is also opposed to customer profitability, which measures past activities to gain insights. Much like how you should be looking into the future to determine which products you should sell, different ways to optimise your business, and how to serve your customers better.
Advantages of CLV
Some advantages of CLV are:
- CLV allows you to measure the financial impact of your marketing campaigns and other activities.
- This will help your brand align better with bigger financial targets in an organisation or start creating them if you are a smaller organisation.
- CLV also changes the way you think about marketing in creating loyalty objectives or focusing on underutilised areas.
- Customer lifetime value will help you balance short-term and long-term marketing goals and demonstrate a better understanding of financial return on your investments.
- CLV encourages you to make better decisions by teaching you to spend less acquiring customers with a lower value.
To sum up, effective management of your customer relationships leads to increased profitability which is the most significant advantage of customer lifetime value.
Why Customer Lifetime Value Matters
Adroll President, Scott Gifis mentions CLV as one of his essential three "quick-win tips" to improve retention.
“Optimize your customer lifetime value (CLV). By doing this, you may realise that you’re spending huge sums on acquiring customers because you haven’t made enough of an investment in your loyalty programs. For example, if your customer acquisition cost (CAC) for a net-new customer is 30% off your first sale, it makes sense to provide discounts and promotions to your past customers at 10-20%. You’ll need to think differently about how you measure and attribute various programs. Vanity advertising metrics and surface-level attribution models, such as last-click, need to be replaced with more comprehensive measurement forms. It’s vital to make an investment in truly understanding your CLV and separate the cost per acquisition (CPA) for new and repeat customers. You’ll probably find that you’re burning a lot of dollars that you could be sharing with your customers via loyalty programs, and driving faster, more sustainable growth.”
Here are 5 ways Customer Lifetime Value matters.
- Helping to determine customer segmentation
- Measurement of customer loyalty
- Determining the efficacy of marketing strategies
- Aiding in the judgment of product quality
- Increasing profitability overall
As Business.com writes, “CLV can safely be called the complete metric for marketing analytics. New customer rates, costs per order, customer retention rates, conversion percentages, and many more are important to your future revenue. Still, CLV combines all the important statistics of every individual customer. It is simply the expected profit you get from each customer in your business. With proper calculations, you can easily grow your e-commerce business with this metric. You won't be losing money because you will know exactly how much you earn.”
How to Improve Customer Lifetime Value
Like any other marketing activity, your CLV process also needs a learning curve and improvements as you proceed further. Let's look at some ways on how you can improve customer lifetime value.
Improve Your Onboarding Process
When it comes to customer success, onboarding is the process you should spare no effort on to ensure sustainable business growth.
When you are done onboarding new customers, now you have to show them some value. Neil Patel’s ten tactics for increasing your customer lifetime value and loyalty focus on making customers feel special.
He writes that “brand loyalty is one of the most difficult assets for a business to attain. Or, at least it was. We used to rely on customers having a great experience with our product/service or our employees. Now, we can give them a great experience, but most businesses still haven’t figured out how to do it.”
Focus on the people who support your brand, which can be done by featuring them in your content. Surprising them with something unexpected is key to increasing your CLV.
Focus on Sales
It's time to focus on the sales, according to the Entrepreneur piece on increasing Customer Lifetime Value and boosting profits, the 3 key strategies are to:
- Increase sales per order
- Increase sales over time
- Reduce costs to serve customers
Entrepreneur writes. “If you don’t pursue one or more of these strategies, it’s unlikely that you’ll see a big uptick in customer retention or customer loyalty toward your brand anytime soon.”
Getting acquainted with your customer’s lifetime value is super important. If you don't focus on improving it, you might be missing out on more significant future profits.
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