Customer Lifetime Value: definition, computation, and importance

Do you know the Customer Lifetime Value? Have you ever tried calculating it for your business? If you need clarification on this topic, you’re in the right place! We’re talking about a fundamental metric for any type of business, especially for a digital one. In this article, you’ll find all the information you need to manage this value effectively and optimize its usage. Specifically, we will explore:

  • what Customer Lifetime Value is
  • how to calculate it
  • why this metric is crucial for businesses
  • how to improve it.

Discover how essential it is for your company to understand Customer Lifetime Value and how it helps in developing effective sales strategies, and making more informed and reasoned marketing decisions.

This metric allows you to delve into the details of how your customers engage with your business. You can thoroughly analyze your customers, build long-term relationships, and fulfill all their desires by refining your sales strategies. To make all of this a reality, you need skills in sales techniques.

Every business’s goal should be to have a skilled and updated sales team capable of devising effective sales strategies and adapting to market needs. To achieve this, you’ll need to acquire the right skills in this area through the Digital Sales Course. With the right Customer Lifetime Value monitoring, you’ll discover the perfect recipe to best satisfy your customers and significantly increase your sales by planning the right strategy.

Meaning of Customer Lifetime Value and Definition

It’s not easy to establish a single definition of Customer Lifetime Value (CLV). Among the myriad definitions found on the web, many focus solely on basic calculations, while others consider only revenues, and still others concentrate on more or less complex operations that take into account gross margin and expenses.

how to calculate customer lifetime value

Considering a general spectrum, the definition of CLV is only one: Customer Lifetime Value is the company metric that measures the average income that a company can potentially obtain from a customer as long as that person or account remains a customer. It is a fundamental measure for the management of the entire marketing and sales department. It involves social, web marketing, and even ads and email.

Customer Lifetime Value is a number. As often happens, however, numbers hide a deep meaning, and this is the case with CLV. This metric provides us with a wealth of information, including:

  • consumer buying behavior
  • customer profitability
  • the quality of the connection between the company and the customer.

As you can see, CLV is a dictionary of your customers. In the following paragraphs, you’ll discover why it’s so important to study and analyze it carefully to ensure the positive operation of your business. Thanks to its simplicity, it is a particularly important metric for all types of businesses, from small companies and startups to well-known enterprises, as it considers all stages of customer-business relationships.

Customer Lifetime Value: how to calculate it and examples

If you are a company and have systems ERP, which is a set of integrated software that coordinates multiple business activities through the use of a single database, you won’t need to take a calculator to calculate your Customer Lifetime Value. In some cases, companies have analytical tools capable of automatically measuring this value. In case you don’t, you’ll be forced to calculate the customer value manually. You’ll need to follow these steps:

computation clv

  • define the average value of your purchases.
  • remember to consider at least the last three months if you haven’t monitored this data in the recent past.
  • calculate the number of transactions per period.
  • measure your customer retention: how long does the average customer remain “loyal” to the brand?

These indicators are the inputs you’ll need to calculate your Customer Lifetime Value. In a way, they are its levers: if, for example, you increase the prices of your products on e-commerce, the transaction value will inevitably rise. However, you must consider that this could lead your customers to make fewer purchases on your site and negatively affect your profits. It’s good practice, therefore, to find the right balance and avoid any undesirable repercussions.

Once you’ve collected all the inputs, you just need to proceed with the mathematical calculation. What formula to use? Here’s the basic formula for calculating the Customer Lifetime Value of your customers:

CLV = average transaction size x number of transactions x retention period

Keep in mind that the calculation of Customer Lifetime Value can consider other variables, including customer acquisition costs and service provided to the customer. In this case, for example, the formula could become:

CLV = customer-generated profits – customer acquisition costs and service provided to the customer

Essentially, you can predict CLV by integrating some functions into the base formula, including behavior models and business costs. The formula can vary depending on the analysis context, product type, and market dynamics in which you operate. When you have identified

By knowing the perfect variables for your business, you will get a precise analysis of what works or doesn’t work in your relationship with your customers, allowing you to refine your technique and work towards total appreciation from your consumers.

Example of Customer Lifetime Value calculation for a SaaS (Software as a Service subscription)

Let’s consider an online video streaming service. There are multiple pricing plans, but the average user spends about $ 17 per month, subscribes for at least three and a half years, and chooses the monthly payment method. With these data, we calculate the Customer Lifetime Value using the basic formula:

CLV = $ 17 (average sale) x 12 (annual purchases) x 3.5 (years) = $ 714

Example of Customer Lifetime Value calculation for an e-commerce

Let’s suppose an online clothing store has an average sale of $ 10. Each customer visits the site once a month, 12 months a year, for an average of five years. In this case, the CLV calculation is:

CLV = $ 10 (average sale) x 12 (annual visits) x 5 (years) = $ 600

As you’ve probably understood, CLV is a dynamic value that opens the door to various types of measurements. By summing all the Customer Lifetime Values you’ve calculated, for example, you can obtain a new value called customer equity, which is the total of customers in your portfolio.

But it doesn’t end here! Once you’ve determined the CLV of your customers, you can also keep an eye on the cost of an individual customer, called cost-to-serve. As you gather more information about your users, you’ll be able to create a more specific picture of their relationship with your brand and structure a sales and marketing strategy that best fits their needs.

 

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Why Customer Lifetime Value is important for companies

When you are aware of the real value of your consumers, you will know exactly how to develop effective strategies for your business to maintain a strong customer relationship and potentially acquire new customers while preserving your profit margins. For this reason, a company needs to know how to calculate the Customer Lifetime Value of its customers.

In addition to concealing several important elements, CLV takes into account other fundamental metrics for a business, including:

  • response and conversion rate
  • purchase frequency
  • purchase value
  • churn rate
  • retention rate
  • customer acquisition cost.

clv important metric

Understanding what this number conceals is not child’s play. You must be able to follow step by step every possible nuance of Customer Lifetime Value to make the right managerial decisions. You will need to carefully study, for example, the possible causes of altered CLV: it could be due to excessive expenses or potential communication crises.

You will also be forced to compare the Customer Lifetime Value with other values, such as customer acquisition cost or Churn rate. This way, you can quickly calculate customer profitability and the potential for long-term company growth. A thorough analysis of your business is the only method that allows you to positively control your company and potentially increase your sales.

In summary, why should every company calculate and monitor the Customer Lifetime Value?

  1. you can adopt specific pricing strategies, and advertising, and refine your customer loyalty technique.
  2. through in-depth analysis, you can optimize costs and increase profits. In short, you can increase the profitability of your business.
  3. you can promote repeat sales and increase this type of activity.

Churn Rate: what is it?

One of the metrics that Customer Lifetime Value must measure is the Churn rate. It is a metric that measures the rate of customer churn. In other words, it is the percentage of consumers who have stopped using your products or services within a certain period. It is typically calculated by dividing the number of customers you have lost by the number of customers acquired in a quarter.

This model is essential for a business, but by taking this data alone, you may not get the answers you are looking for. Customer Lifetime Value is one of the main metrics that should be combined and compared with the Churn rate; for example, if customer Mario Rossi is about to leave, you will need to find new retention strategies and channels, but you will also need to calculate the value of the customer you are losing, hence the Customer Lifetime Value.

This combination will allow you to carefully manage your customer base, identify touch points, and set up profitable marketing campaigns to encourage the sale of your products or services and, as a result, achieve and/or improve your product market fit.

The link between Customer Acquisition Cost and Customer Lifetime Value

CAC (Customer Acquisition Cost) and CLV are two fundamental metrics for every business. By keeping these two values and the Churn rate under control, you can roughly describe the performance of your business. In general, Customer Acquisition Cost is a key strategic performance indicator that assesses the amount of investment and the profitability of your company. In other words, Customer Acquisition Cost answers a simple question: how much does it cost me to bring home a new customer? The value of customer acquisition cost includes all marketing expenses, services, and tools of support needed to acquire new customers. This is the simplest formula to calculate it:

CAC = total marketing costs/total new customers

cac clv graphic

What’s its connection with CLV? It’s good practice to keep the Customer Lifetime Value lower than the customer acquisition cost. In practical terms, the average investment (CAC) must be less than the revenue you will earn from the customer, to achieve a positive ROI (Return On Investment). If this doesn’t happen, you need to change your business strategy and implement new sales strategies to lower CAC as much as possible and increase CLV.

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Improve Customer Lifetime Value in 7 Steps

As you can imagine, there are several ways to improve Customer Lifetime Value and make your business more profitable. Looking at the calculations just performed, it is clear how to order frequency and order value will increase Customer Lifetime Value. The factors contributing to this phenomenon are related to customer loyalty and sales techniques.

By trying to improve your CLV, you can only receive benefits. You’ll enhance your brand reputation, enjoy a steady cash flow, and maximize your sales margins by optimizing costs. As a result, you can reinvest further in your business’s growth. If you’re looking for steady growth, you’ll need to gradually increase this value. Let’s now review some of the most effective methods for improving Customer Lifetime Value.

Reward your most loyal customers

Loyalty programs keep your customers engaged, encourage purchases, and increase the amount of time your customer stays attached to your brand. In this way, you can monitor all potential interactions between your company and your customers, embracing various channels like advertising, customer support, and sales to improve customer loyalty and experience.

Manage your customer relationships effectively

Here’s one of the many methods to enhance Customer Lifetime Value: to create a lasting relationship, it’s essential to understand the relationships and communication history between your business and typical customers. You must monitor the entire customer lifecycle and the time they stay attached to your brand. In this regard, you need to ensure every interaction with your brand is positive, starting from improving customer service.

Keep in mind that, like most humans, your customers seek recognition and want to be heard. When a user has to deal with fast and efficient service, they feel “cared for” and appreciated, making them more likely to return and purchase again. Caring for marketing strategies and customer service is the first step to achieving this goal.

Enhance onboarding and monitor the Churn Rate

Often, after purchasing a product or service from a company, customers feel abandoned. A company must convert an occasional customer into a recurring source of income to increase overall profit. Refining onboarding strategies will help you achieve this.

After a customer’s initial commitment or purchase, the likelihood of churn increases. Therefore, it’s essential to keep customer attention on your brand in the days following their first purchase. Developing effective onboarding strategies means focusing on the customer and the needs of new users, and understanding how to have a positive impact on their experience with your brand.

Monitor customer feedback

Always ask customers what they think of your brand. Companies should continuously solicit customer opinions to improve the user experience in every aspect. Through constant feedback monitoring, you can delve into what works or doesn’t work for your brand, your communication, and how your customer relationship can be enhanced. Surveys and market research are invaluable for companies, especially in terms of adapting to the needs of your buyer personas and offering a product or service that better meets their needs.

 

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Improve your user experience

Is your product or service intuitive and enjoyable to use? A good user experience is a fundamental requirement to increase the value of Customer Lifetime Value. If your customers encounter obstacles while making purchases on your website, they will leave before completing the payment process. On the other hand, if they are satisfied with the purchasing experience, they are more likely to return in the future.

Manage your sales strategies effectively

Customer Lifetime Value provides excellent insights into how you can increase the sales of your goods or services by implementing the most suitable strategy according to customer demands. To achieve this, you’ll need the right skills in the sales field and consider including a sales department within your team.

clv online sales

Redirecting your sales strategies can be an excellent solution to improve your company’s CLV. How can you do this in practice?

  • increase the price: if done correctly, raising the price can have a positive influence on Customer Lifetime Value. The increase, of course, should not be drastic; otherwise, you risk causing the opposite effect, namely, losing many customers and decreasing the value.
  • convince your customers that your offer is much more advantageous than your competitors: this is a strategy to ensure that customers choose your product or service over your competitors. Showcase your unique value proposition and convince customers of the advantages they gain by choosing your brand.
  • optimize customer communication: maintain open communication channels with customers, addressing their concerns and offering support promptly. Effective communication can build trust and loyalty.

Focus on retargeting

As I just mentioned, it’s easier to retain an existing customer than acquire a new one. On average, website visitors exposed to retargeting have a 43% higher chance of converting. To enhance Customer Lifetime Value, it’s also crucial to engage users who have already interacted with your brand. This will help you nurture your brand reputation and encourage previous users to turn to your brand whenever they need to purchase something similar.

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Conclusion and request for more information

In conclusion, the Customer Lifetime Value is at the heart of the engagement between the company and its customers. If you have never thought about considering this value, now is the time to do it. But be careful: its calculation cannot be done one time. You will need to constantly monitor it to identify any alterations and ascertain the best marketing or sales strategy to bring it back to normal.

A careful study of the CLV will allow you to develop profitable sales strategies tailored to your customers. In other words, the more you commit to optimizing your CLV, the higher the revenue your business will record. A good sales manager will know how to calculate these values, actively intervene in achieving revenue goals, and ensure the success of the business.

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