How to Calculate Customer Lifetime Value (LTV)
Introduction
Customers are the heart of most businesses—defining the potential for success, longevity, & sustainability. But like everything in this world, customers can be gained and lost over the lifetime of a company.
However, a genuinely formidable company will keep customers satisfied, yet hungry for more. Eagerly awaiting your next product, update, or offer. This desire for more is what helps businesses survive & prosper long term.
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What is customer lifetime value?
Customer Lifetime Value or CLV Definition:
The measurement of how valuable a customer is throughout their business relationship.
For example, instead of relying on the value of the first purchase, CLV seeks the profit margin expected to be earned over the average lifespan of the customer. A key benefit of tracking this metric is that it enables you to understand a reasonable cost per acquisition.
Your CLV should account for a variety of things including:
Customer acquisition costs, or CAC.
Ongoing sales & marketing expenses.
Operating expenses.
Product or service cost.
This metric is highly valuable to include, yet surprisingly many companies don’t utilize it as much as single sale metrics. However, many studies are indicating that repeat customers are more valuable than first-time buyers.
The power of loyal, repeat customers:
When you consider the results of these studies, you can begin to understand how even the slightest optimization in customer retention rates can have a dramatically positive impact on the success and longevity of a business.
How to calculate the lifetime value of a client
Since these calculations are based on financial projections, it requires businesses to make informed estimations. Therefore, the more established a company is, the more historical customer data they can use, the more likely their calculation will be accurate.
To calculate CLV, a business must estimate the value of three things.
The average value of a sale.
The average number of transactions per customer.
The average duration of their business relationship.
So, in essence, the formula for calculating the customer lifetime value is:
However, it doesn’t end there. We need to include operating expenses and cost per customer.
To calculate the cost of a customer, we need to consider:
The cost of making the product.
The cost of advertising the product.
The cost of managing operations.
So, the formula for calculating the customer lifetime now becomes:
The most straightforward variation is:
Customer lifetime value example
We will use a hypothetical company to showcase how this calculation works.
A General Tech Store
Average Sale | $75
Average Customer Shops | 2 x Per A Year
Average Customer Lifespan | 3 Years
SO, THE EQUATION WOULD BE:
Lifetime Value = $75 x 2 x 3.
Total = $450
Then we have to account for the cost of a customer. The tech store’s average profit margin is 30%.
SO, THE EQUATION WOULD BE:
Customer Lifetime Value = $75 x 2 x 3 x 30%
Subtotal = $450 x 30%
Total = $135
This calculation indicates that the customer lifetime value of the average tech store customer is $135, far less the initial calculation of $450. Once you have calculated this number, you can then calculate how many customers you will need to retain profitable business.
Factors that influence a customers lifetime value
What is the best type of customer to have? A loyal one. Firstly, they are more likely to stay around longer than your average customer lifespan. Secondly, they are likely to recommend you to others and help you gain new business. Finally, they are not as likely to switch over to the competition.
On the other hand, if there is no brand loyalty, then we must consider how costly the customer will be. Especially if they leave for another company, leave a bad review, or ask for refunds. There is a saying that it takes 12 good reviews to remove the damage of one bad review.
Customer loyalty is almost priceless.
Customer loyalty is defined by their sense of dedication to a brand. A customer with no allegiance to a brand is considered brand agnostic. It is an excellent practice to increase your customer’s sense of brand loyalty as it directly correlates to an increase in customer retention and a natural decrease in customer churn.
Become aware of your churn rate & optimise it
A churn rate is defined by how many customers unsubscribe or stop shopping with your business. Every business is different; some acquire a competitive edge and loyalty programs that help retain more customers and lower churn rates. While other products and services are more likely to be a one time buy.
The formula for calculating churn rate is:
The total number of customers at the start of a given period.
Minus the total amount at the end of the given period.
Then divide that total by the number of customers at the beginning of the year.
For example, if the tech store had 500 loyal customers at the start of the year, but in the end, they only had 350.
The formula would be: 500 – 350
Subtotal = 150 ÷ 500
Total = 0.3 or 30%
So the total churn rate for the tech business is 30%. One of the top factors for customers leaving a company is poor customer support. Thus simply optimizing this area of your business could reduce churn by upto 89%.
Diversify & scale your sales + marketing strategies
Scalable sales & marketing strategies are essential for keeping your business afloat during change. Since many businesses’ revenue growth and marketing expenses are intertwined, it’s crucial to create backup plans to prevent a loss, if revenue was to decrease.
You can achieve this by split testing campaigns, testing new channels, and performing regular CRO. Tracking and optimizing these key metrics will enable you to perform quick strategic moves to minimize loss and keep your business growing.
How to improve the lifetime value of a customer
For each different kind of business, there is a different set of barriers and benefits to increasing CLV. For example, some companies are one of a kind and have the luxury of little to no competition. While most companies aren’t as lucky and have to implement tactics through targeted methods that help increase customer loyalty.
Your business is just like any relationship; first impressions count, excellent communication is essential, making them feel special & creating rewarding experiences keeps them coming back for more.
Optimize your first impression
The churn rate is highest after a customer’s first experience with your brand. So what better way to prevent churn than at their first impression, usually when they are onboarded. Effective onboarding is as simple as offering excellent customer support methods and being attentive to their needs.
Offer superior communication
Make your brand feel human, offer an open line of communication that will quickly guide the customer down the best path. Customers value being heard. It’s particularly vital when it comes to negative reviews, feedback, and comments. When you address this, you address that individual & anyone else who might come across it and have a similar concern. This simple practice can dramatically improve the chances of repeat business.
Make them feel special
One of the best ways to incentivize repeat customers is by giving them a rewarding loyalty program and personalized customer experience. This can include loyalty or reward points, VIP discounts, and target adverts based on products they viewed with bonus coupons.
Keep them engaged
Sometimes we forget about the products or services we use to love. That is why it is crucial to renege old customers with your products, offering personalized deals and rewards for their ongoing loyalty. This step is essential for prolonging the customer lifespan and increasing the overall CLV.
Increasing your customer lifetime value is a vital attribute for sustained success
Optimizing all the factors and practices mentioned above can be the difference between your business barely surviving and reaching new heights. The cost of retaining past customers will always be cheaper and more beneficial, then acquiring new customers.
Your business is just like any relationship; first impressions count, excellent communication is essential, making them feel special & creating rewarding experiences keeps them coming back for more.
