Attracting new customers is much costlier than retaining existing ones. And how do you know if your existing customers will spend more money with your business in the future? It’s simple: measure the Customer Lifetime Value (CLV).
Can you predict how long the customer will stay loyal to your brand and buy your products or services in the future? Or have they already stopped purchasing from you?
One way is by calculating the Customer Lifetime Value or CLV. It shows the customer’s relationship with a business. And whether the customer values the business over a specific period.
Knowing this key metric helps businesses retain existing customers. Today’s businesses must create better customer relationships by focusing on their experiences through many different touchpoints.
Explore all about Customer Lifetime Value and know how to increase this important KPI in digital marketing.
What is Customer Lifetime Value?
Customer Lifetime Value is a metric a business owner estimates the total revenue a customer will likely spend with the business over a certain time.
If customers spend more time with the business, they will spend more. In other words, the Customer Lifetime Value will increase. With a high CLV, a business has a larger, valued customer base that is loyal.
Three Components of Customer Lifetime Value
Customer Acquisition Cost
The amount spent on marketing to attract each customer is termed the customer acquisition cost (CAC).
Customer Acquisition Cost = Total Money Spent on Marketing in the Year / Number of new customers in the Year
Annual Profit from Customer
This component refers to the profit margin your business makes from the customer in a given time period.
Average Lifetime of Customer
How long has the customer spent with the business, and how much have they spent in a given time period refer to the average lifetime of customer.
How to Calculate Customer Lifetime Value with Example
The calculation for Customer Lifetime Value is done through this formula. Note that this basic calculation does not consider the customer acquisition cost, inflation, and other factors.
Customer Lifetime Value (CLV) = Average Purchase Value x Average Purchase Frequency x Average Customer Lifetime
For explaining purposes, let’s look at a basic example.
A customer visits a coffee shop thrice a week and spends around Rs 250 on each visit. And this customer has been visiting that same coffee shop for two years.
Average value per purchase = Rs 250
Average number of purchases per year = 3 visits per week x 52 weeks per year = 156 visits every year
Average customer lifetime = 2 years
The CLV formula, then is
CLV = (Rs. 250) * (156 visits/year) * (2 years) = Rs. 78000
Multi-period Calculation of CLV
Multi-period CLV involves projecting future revenue and costs over the customer's lifespan. It accounts for factors like purchase frequency, average order value, and retention rates.
Imagine you run an online subscription-based streaming service. Let's say the average monthly subscription fee is £10, and your typical customer stays subscribed for 24 months. However, retention rates can vary over time.
In this scenario, you'd first calculate the average revenue per month per customer (£10). Then, you'd estimate the likelihood of a customer remaining subscribed each month. For instance:
Month 1: 90% retention
Month 2: 85% retention
Month 3: 80% retention
and so on...
You'd continue this pattern for 24 months. Using these retention rates, you can project the revenue from each customer over their lifetime and sum it up. Subtract any associated costs (like customer support or content licensing fees) to get the CLV.
Monthly subscription fee: £10
Average customer lifespan: 24 months
Monthly retention rates (percentages):
Month 1: 90%
Month 2: 85%
Month 3: 80%
and so on...
We'll calculate the revenue generated from each customer over 24 months and sum it up.
Revenue per customer = £10 (subscription fee)
Total customers = 1000 (example)
Revenue in Month 1 = £10 * 1000 = £10,000
Assuming 90% retention from the previous month:
Revenue per customer = £10 (subscription fee)
Total customers = 900 (90% of 1000)
Revenue in Month 2 = £10 * 900 = £9,000
Continuing this pattern, we calculate revenue for each month up to Month 24.
After calculating revenue for all 24 months, we sum up the total revenue:
Total Revenue = Revenue Month 1 + Revenue Month 2 + ... + Revenue Month 24
Finally, we subtract any associated costs (like customer support or content licensing fees) to get the CLV.
Factors that Affect the Customer Lifetime Value
The customer lifetime value should also be measured based on churn rate and customer retention rate, among other factors.
The churn rate calculates the rate at which customers stop purchasing from the business after a time period. It is also known as the attrition rate.
A simple calculation of customer churn rate goes as,
Customer Churn Rate = Customers in the year’s beginning – Customers in the year’s end / Customers in the year’s beginning
Reasons such as better industry competitors, lack of loyalty programmes with the current business, etc., are common.
To improve customer lifetime value, a business has to reduce the churn rate.
Customer Retention Rate
The customer retention rate is the calculation of customers who keep purchasing from the business after a defined time period.
Look at this formula, calculated on the basis of a year.
Customer Retention Rate (CRR) = ((Customers acquired at the end of year – Customers in the whole year) / Customer acquired in the year’s beginning) x 100
Businesses must improve the CRR to increase customer lifetime value.
Importance of Customer Lifetime Value
Why is CLV important to measure? See the reasons below.
Long-Term Business Growth
A high CLV shows that a business earns more profits in the long run. Providing an exceptional customer experience goes a long way in retaining high-value to low-value customers.
Improve Marketing Efforts for Customers of High Value
When running marketing campaigns, you can target the preferences of your high-value customers and strengthen that relationship. You can personalise the campaigns just for them and benefit from more sales.
For your low-value customers, personalise communication differently than what you did with high-value customers.
This kind of customer segmentation will get you better results instead of using the same communication for high- and low-value customers.
Tips to Increase Customer Lifetime Value
Retaining customers is easier said than done. Customer retention is the hardest, even after the lead converts. While customers go through the marketing funnel and make a purchase decision, the business has to ensure they are satisfied post-purchase.
Customers today expect loyalty programmes, personalised emails with offers and discounts, and much more. And these are some methods to increase the CLV.
Depending on our industry, you should also look for signals of the customer’s purchase frequency. If you are a clothing brand, you may want to look into purchases from your customer based on seasons.
If you are an eCommerce store, look at the abandoned cart. Create an email campaign just for those customers who have abandoned their carts. This is one way to improve the conversion rate.
Analyse your competition. Find out if the audience or low-value customers prefer communication on one channel you do not use. Emphasise communication in the mediums your customers prefer.
Use email marketing tools to segment and communicate with high-value customers and low-value customers differently.
Also read: Relationship Marketing