If you run a customer-facing business, then your early marketing strategy probably focused on attracting new customers. But before long, some of that focus split toward bringing those same customers back again. And again.
To retain customers, you’ll need to understand customer lifetime value: the total revenue customers generate during their relationship with you. If you calculate this metric and apply its lessons, you’ll be better able to satisfy your most valuable customers—and they’ll reward you by raising your bottom line.
What is customer lifetime value?
Customer lifetime value (CLV) is how much you can expect to make from a customer from the first transaction to the last. CLV is an important way to examine how well you’re retaining customers, and you can measure it for all customers or for specific segments.
You can also find CLV historically or predictively, for different insights. Historical CLV measures the lifetime value of your existing customers, while predictive CLV estimates the lifetime value of future customers (based on your data).
Why is customer lifetime value important to your business?
Optimize your business strategy
Examining the CLV of different customer segments can help you see where your marketing efforts have produced the most revenue, and therefore demonstrate where you should reallocate funds to increase revenue in the future. Anywhere that CLV is high is a good place to strengthen your strategy, while you may consider refiguring or abandoning your strategies that bear low CLV.
Adjust your acquisition budget
You may expect higher or lower CLV depending on the nature of your business. One way to find what’s right for your budget is to compare your CLV to your acquisition costs and adjust as necessary. For example, if your average customer buys from you once per week for up to several years, you can afford to spend more acquiring new customers than if your average customer buys from you once and seldom returns.
Understand your customers
While you might already recognize some of your most loyal customers, you can use CLV data to better understand who your brand is appealing to. This will allow you to hone your marketing toward the new and existing consumers most likely to do business with you.
How to calculate customer lifetime value
1. Choose a period of time
Choose a period of time for which you want to analyze your customer data. This can be any period of weeks, months, or years for which you have data.
2. Calculate your variables
First, use your data to find your average purchase value—how much your customers spend with you—using this equation:
|First, use your data to find your average purchase value—how much your customers spend with you—using this equation:
|Avg. purchase value (PV) = Total revenue during your given period divided by total number of purchases during that period
|Second, find your average purchase frequency rate—how many repeat orders your customers make—using this equation:
|Avg. purchase frequency rate (PFR) = Total number of purchases during your given period divided by total number of customers during that period
|Third, find your average customer lifespan—the length of time between your first and last transactions with a customer—using the equation below. Be sure to keep your time unit consistent here. For example, if you’re analyzing six months’ worth of data, count your customer lifespans in months, as well.
|Avg. customer lifespan (CL) = Sum of customer lifespans divided by total number of customers
|Last, find your customer retention rate—the percent of customers you retain over a period—using this equation:
|Customer retention rate (CRR) = Customers at the end of your given period X 100 divided by customers at the start of that period
3. Forecast your revenue
Now, multiply your average purchase value, purchase frequency rate, and customer lifespan, then divide the result by your customer retention rate. The complete equation looks like this:
|Now, multiply your average purchase value, purchase frequency rate, and customer lifespan, then divide the result by your customer retention rate. The complete equation looks like this:
|CLV = PV × PFR × CL divided by CRR
Remember, the variables you calculated will be different for customers who reach you through different channels or purchase different types of products, so you should calculate CLVs for different individuals and segments to fully understand your business.
How to increase your customer lifetime value
Once you calculate CLV for different segments, you can use it to determine where your marketing and product focus should be. But remember that CLV—like your business—is dynamic. Your variables will change over time, so recalculate your CLV semi-annually and reallocate resources as needed to improve your customer experience with personalized marketing, including recommendations, cross-selling, upselling, business or influencer collaborations, exclusive content, and more.