Customer Lifetime Value: How To Calculate And Why Is It Important?

It is approximately 8 times costlier to acquire a new customer than retaining an old one, and companies lose around 20% of their customers annually, even with their best efforts! There are various techniques which can be a helping hand in customer retention and customer acquisition, and Customer Lifetime Value (CLV) is one of them.

Let’s start with the term – Customer Lifetime Value or Lifetime Value or Lifetime Customer Value.

What is Customer Lifetime Value?

According to Wikipedia,

“In marketing, Customer Lifetime Value (CLV or often CLTV), lifetime customer value (LCV), or Lifetime value (LTV) is a prediction of the net profit attributed to the entire future relationship with a customer.”

But in a nutshell, Customer Lifetime Value a.k.a. LTV means the revenue generated by a customer in his entire lifetime.

This term became extremely popular from 1990 as it gives you a theoretical figure of how much a customer will generate revenue to the company. Based on prediction, marketing team can derive the rough amount to spend on customer acquisition process.

In a simple way, if the COCA (Cost of Customer Acquisition) is 120$, and the lifetime value of the customer is 150$, that’s a profitable customer! Apart from that, here are some uses of LTV:

Designing customer acquisition strategies.
Determine levels of investments in marketing strategies.
Designing customer satisfaction strategies.
Deciding customer retention strategies for individual customers.
Measuring customer loyalty.
Improving Net Promoter Score.

How to calculate Customer Lifetime Value (LTV)?

There are multiple methods of calculating LTV, but we are going to discuss these two methods which are widely popular:

  1. Historic CLV
  2. Predictive CLV

Historic CLV:

CLVH = (T1+T2+T3+T4……..TN) * AGM

Where,

T1 = Transaction 1
T2 = Transaction 2…
AGM = Average Gross Margin

Average Gross Margin =(Revenue – Cost of Goods Sold (COGS))/Revenue

This formula is the simple calculation of Customer Lifetime Value where previous transactions from the customer are considered. This formula will give you the actual numbers of a customer contributing in your business.

For a small business, this can be extremely useful as there are limited customers to fulfill the product or service.

Predictive CLV:

Predictive CLV is more accurate compared to the Historic CLV. Here’s the formula to calculate:

CLV1 = ((T* AOV) AGM ) ALT

Where,

T = Average monthly transactions
AOV = Average order value
AGM: Average gross margin
ALT: Average customer lifespan

This formula will give you predictive customer value for a decided life span. But, in actual scenarios, there are multiple discounts provided to the customers. Hence, here’s more realistic formula to calculate Customer Lifetime Value.

We will use the above formula in this equation:

CLV = CLV1R/((1 + D – R))

Where,

R = Monthly retention rate
D = Monthly discount rate

Why Customer Lifetime Value is important?

1.Gives you insights of every marketing channels:

To acquire customers, you use various marketing and advertising channels. Finding out which channel gives you the best customers is extremely important, that’s the reason in some feedback forms there are questions like “How did you find us?”

By finding out the best channels of marketing, you can focus more on such channels to acquire more customers. On the other hand, you can spend lesser money on the channels which are not profitable to your organizations.

Sorting out best customers by their marketing channels will also give you insights about how much to spend on such marketing channels.

2. Retain your customers:

In the process of finding Customer Lifetime Value, you will find out the repetition of the customer to your brand.

How many times in a month the customer is coming back to us?
What amount of purchase does he do?
What kind of purchase does he making?

Such questions will be answered in the process of finding CLV. You can make individual strategies for such customers to retain them to your brand. With a personalized discount, a great customer relationship can be built.

3. Improve your Net Promoter Score:

When you find the Lifetime Value, you can find three kinds of customers:

Promoters
Passives
Detractors

Promoters are the customers who are dedicated and loyal to your brand. They will stick with you brand for a long period of time, and you will realize it when you’ll find their CLV. They will promote you brand, and spread good words.

Passives are the customers who will choose your brand for a certain period of time. But, they can be easily distracted! They may not spread a bad word of mouth, but they will choose a different product if there’s a better opportunity.

Detractors are the customers who have had a bad experience with your product or service. They will speak ill about your brand, and may hurt your business. These are the customers whom you should worry about the most.

Now, you may not want to worry about Promoters, as they are deeply in love with your brand. But, you can convert the Passives and Detractors by personlised offers. Here’s an example of a Passive customer who turned out to be our classic Promoter:

By figuring out CLV, you can decide necessary strategies for every kind of customer. These customers will slowly become your promoters and your NPS will raise.

Bottom Line:

As we can figure out by now, the Customer Lifetime Value has a lot to do with customer satisfaction. But, there are multiple methods to figure out the CLV, so it’s beneficial to find the right method for your organization, and start working on it!

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