What is customer lifetime value?
Analytics are crucial to a startup. Many metrics help you understand your customers. Net Promoter Scores (NPS) and Customer Satisfaction (CSAT) are valuable tools. Customer lifetime value (CLV) is not to be overlooked. It’s the customer metric that’s most connected to your bottom line.
CLV provides insight into the revenue you generate over the lifetime of your business relationship with a customer. You can also apply it to segments of customers. It takes account of the investment needed to acquire and retain a customer and reveals the profit you should be able to extract.
Why is CLV important?
It is tempting to put all your efforts into customer acquisition and making big sales. CLV reminds you of the value of customer loyalty. Use your CLV to contribute to a robust QA framework, ensuring you provide the best customer experiences possible.
Intimate knowledge of CLV will assist in long-term planning. The top 3 reasons to track CLV are as follows:
#1: It helps reduce customer acquisition costs.
It costs five times more to acquire a new customer than it does to retain an existing one. It’s plain to see that impact on your margins.
#2: It helps guide marketing decisions.
CLV shows you which kind of customer spends the most. That will assist you in developing a marketing strategy that targets those customers.
#3: It boosts income over the long term.
Paying due attention to CLV will increase profitability. This is thanks to the reduced costs and increased focus on marketing decision-making.
What negatively impacts CLV?
When thinking about CLV, it’s helpful to consider the brand funnel. A brand funnel helps you visualize a customer’s journey with your business. From learning about your brand to becoming a regular customer and advocate.
As customers fall away, the funnel narrows. A business that prioritizes CLV should expect a wider end of the funnel. It’s wider because fewer customers have fallen off. Some reasons for customer falloff are:
- Your product or service doesn’t meet customer expectations.
- Competitors have lured customers away.
- Customer support lines are busy because of high-volume calls.
- You haven’t given customers a reason to buy again.
Once you have a handle on your CLV metric, you’ll be able to spot and address issues like these.
The rate at which customers fall off is known as the churn rate. You calculate this by taking how many customers you had at the beginning of a period and then subtracting the number of customers you have at the end. Then divide the difference by how many customers were at the beginning and multiply by one hundred.
Let’s take the example of a sushi restaurant. At the beginning of Q2, they fulfilled 20 lunch orders a day. Something fishy happens though and by the end of Q2, they are only getting 15 orders for lunch.
That gives the sushi place a churn rate of 25%. If that pattern continues, they’re dead in the water. They need to do something to keep things fresh for their existing customers.
How to calculate CLV
To get your CLV data, you’ll need to do some calculations. The information you gain through your calculations is only as good as the information you put into it. You will need:
- Average purchase value (APV): This is the value of all transactions over a period of time, one quarter, for example, divided by how many transactions took place.
- Average purchase frequency (APF): This is the number of transactions, over the same period, divided by the number of individual customers.
- Customer value: This is APV multiplied by APF.
- Average customer lifetime: This is the average length of time you retain a customer.
Formula for success
To get that CLV figure, what you need to do now is multiply your customer value result by your average customer lifespan.
CLV= customer value x average customer lifetime
The customer lifetime value figure you have calculated is the average amount of money you can expect to earn from the average customer.
Let’s go back to the sushi restaurant to put this into practice. We’ll imagine they have solved their churn rate problems and have a loyal customer base. The average bill comes to $40 and the average customer eats there three times a quarter for two quarters.
Gross customer lifetime value= $40 x 3 x 2 = $240
This figure tells us something, but not everything. It doesn’t account for the cost of ingredients, labor costs, advertising, etc. The sushi restaurant has a profit margin of 25%. Let’s recalculate with business costs now taken into account.
Customer lifetime value= $40 x 3 x 2 x 25% = $60
Understanding your CLV with costs taken into account will provide a better picture. It will provide insights into how much you should invest in attaining new customers and help you maximize profitability.
Different ways to calculate CLV
Historical customer lifetime value
By using past data to calculate CLV, you get a good window into the buying behavior of active customers. What isn’t taken into account, however, is the possibility of returning inactive customers.
This model, then, has some drawbacks. It doesn’t take into account the different kinds of customer journeys. It discounts customers who may buy from you again.
Predictive customer lifetime value
Through using the latest customer analytics technologies, you will be able to predict future CLV. You will need a robust database of customer information to do this. This has obvious advantages in making planning decisions.
By taking account of your churn rate and predicted customer attainment, you will be able to calculate CLV more accurately. The formula is the same, you’re just plugging better information into it.
Calculating CLV by different customer segments
There are various journeys a customer can take with your business. Through segmenting customers into groups, you will be able to calculate CLV for each of them. The benefit to your business is you will be able to see which groups provide higher CLV and target them accordingly. It will also point out groups on which to focus your efforts to improve CLV.
To segment your customers, you will need to lean on your database of customer details. Use demographics, purchasing behavior, and other commonalities to segment your customers. You will then be able to calculate CLV for each group.
How to increase your Customer Lifetime Value
Now you’ve got a handle on CLV, you need to know how to use it. Take the insights provided by CLV and take action. You can improve your ratings with your active customers and bring in new ones too.
Your CLV may reveal that many customers stop buying your product or service more quickly than is optimal. This is because of the dreaded churn. Show your customer-facing teams what your calculations have revealed. They will be able to make improvements to the service they provide and drive better CLV.
Customers are put off by poor support. They will take their business elsewhere if they feel they are being shifted from pillar to post while trying to get telephone support. If you implement skill-based routing of support calls then customers will quickly have their queries resolved.
By improving customer relations, you will be able to extend the customer lifetime. A longer relationship will result in a higher CLV.
#2: Marketing focus
Understanding your customers allows you to be efficient in your marketing efforts. CLV data can teach you many marketing lessons. Through your CLV calculations by customer segments, you’ll be better equipped to decide on marketing priorities. You will know which customers provide the most income, thereby boosting your CLV.
#3: Under promise, over deliver
Customers are much more likely to offer return business if they feel their expectations have been surpassed. If there’s something your business offers that’s not 100% deliverable, don’t promise it.
For example, a customer orders a product on your website but then receives an email apologizing because you’re out of stock. This is either because of a sub-par retail inventory management system or lackluster website updating protocols. Don’t disappoint active customers or your CLV will suffer.
#4: Quality Experiences
CLV helps you identify which customer experiences are the cream of the crop, and which are the bottom of the barrel. It’ll give you the insight needed to make decisions around which channels customers are engaging with. You may find your highest value customers prefer to engage via social media, for example, so you’ll know to prioritize investment there.
To sum up…
The purpose of these calculations is to find ways to boost your fiscal performance. In combination with metrics like NPS and CSAT, CLV should guide your decision-making in matters of customer relations, attainment, and retainment.