Customer Lifetime Value: What is It and How it Impacts Your Business

As a business owner, you should know that your business would be nothing without your customers. Hence, it’s important to invest enough time, effort, and resources into factors like tracking your customers’ journey, providing a great customer experience, and improving content.

If you want to ensure that your business succeeds in the long term, you should calculate your Customer Lifetime Value (CLV) and use it to improve your business strategy. But what exactly is Customer Lifetime Value? And how important is it to know this?

Table of Contents

What is Customer Lifetime Value?

Why Calculate Customer Lifetime Value?

How to Calculate Customer Lifetime Value

How to Use CLV to Optimize Your Business

How to Improve Your Customer Lifetime Value

Mistakes to Avoid When Calculating or Using CLV

What is Customer Lifetime Value?

Customer Lifetime Value, or CLV for short, is the total amount that a single customer spends with your company during their entire lifespan as a buyer from you. The key to understanding CLV is not just in knowing how much they spend but how often they purchase, too.

This metric is very important for every business, even growing ones. With CLV, you can determine how valuable a customer will be to your company over his entire life as a client. A customer’s relationship with a business depends on the type of product you offer, what relationship you have with your customer, and more. In short, even with the same business model and similar products, two companies will have very different CLVs.

If a person has been purchasing a $20 turkey at a particular grocery store every Thanksgiving has decided to stop buying turkey at that store after four years, then that customer’s CLV is $80, minus the customer acquisition costs.

This strategy has helped many business owners get a clear picture of how well they are connecting with their clients, which usually propels them to upgrade their acquisition and retention marketing strategies so they don’t lose them.

Why Calculate Customer Lifetime Value?

There are a lot of reasons why you should calculate Customer Lifetime Value. Some of them are as follows:

• It Improves Client Relationship

If you know your CLV and you see that it is low, you will do your best to increase it. One of the ways to convince customers to come back and buy more is through better customer service.

A weak client relationship will lead to fewer repeat purchases which will automatically lower your customer lifetime value. Knowing the wants of your clients and understanding them will build a stable relationship and solidify their trust.

A satisfied customer will be back to patronize you and refer friends to the store, which in turn, increases your CLV.

• Helps in Budgeting

You know how much you can spend in retaining and serving the existing customer when you know the worth of each client.

Customer lifetime value makes it safe to plan what you do with your profit with no fear of losses since you now know your budget limits. It provides answers to important questions like how much you need to invest in winning back customers or retaining them, and how much you should spend on acquiring new customers.

• Helps in Determining How Long before Return of Investment (ROI)

There is a cost attached to customer acquisition. Sometimes the value of the first purchase will not be enough to cover that cost. depending on the type of product and the frequency at which the customer will purchase from you, you will be able to determine how long before your investment pays off.

• Help in Identifying the Customer with the Highest Value

With customer lifetime value, you get to know your highest profit-making client. With this, you not only decide on how much you are willing to spend in retaining such customers, but it would also influence your marketing decisions on what customer segment you should focus on.

Not all customers are equal in terms of the revenue they provide or the cost of acquiring them. A client that buys shoes worth $150 once a year is different from one that purchases shoes every quarter.

• Better Planning

Since your customer lifetime value helps you know the group of customers that are likely to generate a high rate of profit to your business, you can then check how well your products or services are suited to your best customers.

You can strategize plans on how to adapt to their purchasing habits, get products they will be interested in buying, or even set up a special rewards program for them.

• Helps in Knowing Your Business’s Health

With customer lifetime value, you get to look at how well your business will perform over a longer time frame. When you know your business’s health, you can determine if your current customer strategies are ideal for just immediate wins or for steady growth over a long period of time. Then you can make adjustments as needed.

How to Calculate Customer Lifetime Value

When calculating your customer lifetime value, you could choose from a variety of formulas. The formula you decide to use will depend on your business and the resources present at your disposal. It’s advisable you choose the right formula for yourself and stick to it.

At the simplest form, the CLV is equivalent to the amount of profit gained from the customer the entire time he had a relationship with the company, minus the cost of customer acquisition.

However, businesses with complex processes demand more than just a simple formula. Adopting a formula for computing CLV will depend on the information you have and what you hope to achieve.

There are three main methods for CLV calculation, and they are explained below:

1. Historical Customer Lifetime Value

This model of CLV puts your customers’ history into consideration by summing up all the gross profit acquired from their past purchases. When finding the sum of gross profit, you’ll need to consider all values up until the very last transaction a customer made (this is known as Transaction N). You can also measure the CLV based on net profit to easily get the exact amount of profit a customer generates for your company.

There are two ways you can calculate Historical CLV:

Aggregate Method

This involves calculating the CLV by using all previous transactions to determine the average revenue.

Grouped Method

This follows the Aggregate Method, but involves segmenting the customer into various groups based on their transaction data, and then determining the average profit of each group. This is focused on groups of customers, not just individuals.

The general formula for calculating Historical CLV whether you decide to use the Aggregate or Grouped method is as follows:

CLV = (ZT * AGM) / PC

Where,

ZT = sum of all transactions

AGM = Average Gross Margin

PC = number of purchasing customers

Average Gross Margin is the profit margin you set across all your products, on average. It must be in percentage.

With the grouped method, you only consider the transactions and customers falling in a single segment.

The problem with this CLV calculation method is that calculating on the individual ground can be complex especially since the figure needs to be updated every time a customer makes a purchase. It however helps you thoroughly understand your customers’ profitability.

Also, there are extremes that you will not be able to account for. For instance, one customer buys a total of $1,000 in a transaction, and another customer buys a total of $10 in a single transaction. Unless you were able to separate these into groups (the former one falling under VIPs, the latter falling under low buyers), the CLV you get will be highly inaccurate.

Historical Customer Lifetime Value may not always be suitable because you are not able to account for how long your customer remains a customer, which is an important aspect in calculating the lifetime value.

2. Predictive Customer Lifetime Value

This model of CLV calculation aims to get insight into what actions your customers will take in the future (purchase-wise) by taking their past transactional behavior into consideration.

There are several formulas you could use to calculate Predictive CLV, but we’ll focus on the simplest one.

CLV = AT * AOV * ALT * AGM

Where,

AT = Average monthly transactions (per month or per year)

AOV = Average order value

ALT = Average customer lifetime (of having a relationship with the company, in months or in years, depending on what time metric is being used in AT)

AGM = Average gross margin

This can also be used by new companies to predict their own CLV by relying on their competition’s publicly available data. That is if they can get hold of those data.

3. Traditional Customer Lifetime Value

This is the most frequently used formula by eCommerce businesses. It is very simple and uses all the current data you have available.

CLV = AOV * APP * ACL

Where,

APV = Average Order Value

APP = Average Number of Purchases per Person per Year

ACL = Average Customer Lifespan (in Years)

What if you don’t know your customer lifespan yet since your business is pretty new? This is where you must do some digging to find the average lifespan of customers in companies in the same line of business as you are.

Now there is no need to stay within a specific formula once you perceive that the initial formula you chose no longer works for you.

How to Use CLV to Optimize Your Business

After calculating your customer lifetime value, the next thing to do is to use it. Determining your store’s customer lifetime value already places you in a strategic spot above a lot of other e-commerce store owners.

However, knowing precisely how to use this information to your advantage is what makes you really stand out. With customer lifetime value, you can make good decisions that will lead to success in the future.

Below are a few ways you could apply your customer lifetime value:

• Find the Best Acquisition Channel

It’s common to assume that calculating customer lifetime value is only useful for determining the average performance of your store, but it also goes hand in hand with customer segmentation.

Knowing the Customer Lifetime Value per channel can lead to significant improvement in your customer profiling and segmentation. This in turn makes it easier to target customers based on their potential value.

After analyzing the customer lifetime value of all your current customers, you will gain useful insight into the appropriate amount of investment you should make in customer acquisition, along with the most effective acquisition channels.

To achieve this, you will have to group your customers according to their acquisition channels.

Doing this and applying customer lifetime value will reveal the channel with the most profitable customers, along with the worth of customers from each channel.

Assuming you noticed that you weren’t getting a lot of customers from a particular channel, social channels, for instance, you may immediately decide that the best move to make would be to implement a social media advertising campaign to boost the numbers.

But what if the social channel is actually a low-cost acquisition channel, and the reason you weren’t getting enough customers from it is because you are not spending enough, then you would have implemented a losing strategy!

When you know the customer lifetime value of different channels of acquisition, you can then allocate more resources to the best channels or simply repeat the strategies that already worked in acquiring the customers from those channels.

In addition, the customer lifetime value of your acquisition channels can help determine how much you should be willing to invest per customer in each channel.

For instance, if you find that the customer lifetime value of a video ad and a banner ad customer are $302 and $151 respectively, then you should know that you’d have to invest double the cost of a banner ad customer to acquire a video ad customer.

• Determine the Best Areas to Focus on for Increased Revenues

Basically, your customer lifetime value is made of three important factors – your Average Order Value, Purchase Frequency, and Customer Lifespan.

Looking at it this way, when you calculate your customer lifetime value and analyze it, you will easily see the areas where improvements need to be made and then invest there more. This is useful if you have limited manpower and budget as you want to spend most of your resources on the aspect that needs the most improvement.

1. Based on Average Order Value

If you observe that your Average Order Value is the lowest among the three factors, you can work towards boosting it with approaches like product bundling, personalized product recommendations, upselling, cross-selling, and others.

2. Based on Purchase Frequency

If the problem area is your customers’ Purchase Frequency, you can look into tactics like awarding points for specific actions and addition of game elements like point-scoring and competition with others. This is also where you can utilize SMS Message Marketing to bring your customers back to your online store more often than they would if you did not touch base with them or if you use a different marketing tactic.

3. Based on Customer Lifespan

If the problem is with how long the person remains a customer, then you can increase your customer’s lifespan with the use of Loyalty Promotions. The longer they stay as a customer, the better the benefits!

4. Based on Customer Lifetime Value

Finally, if the CLV is too low, then you should utilize a combination of marketing methods, including improving customer service via SMS messaging, discount promotions, loyalty programs, and more.

• Determine Which of Your Customers Are Most Profitable

Another way you could apply customer lifetime value is in finding out your most profitable customer segment. This can be achieved by using customer lifetime value calculations on different demographic factors such as location, financial capacity, age group, browser, gender, and so on.

Doing this will help you determine the profile of your best customers so you could customize the products or services you offer them to suit their needs.

For example, if you decided to conduct a customer lifetime value analysis on customers from different states, you would know the location that’s most profitable for your business. With that, you could then target your CPC ads more effectively and tailor your store’s website content or products to get the attention of the demographic that profits your business the most.

After using customer lifetime value to identify your most profitable customers, you can then develop strategies to keep them and get them to spend more.

• Improve Your Business Forecasting

You can use customer lifetime value calculations to predict the future needs of your business in terms of the products and services you offer. The information gotten from this will be invaluable in managing the investments you make in your business into areas like inventory, workforce, or other business resources. This way you can mitigate productivity losses and apportion your resources more effectively.

• Adjust Your Customer Acquisition Cost

CLV is a great determinant of how much you should spend to acquire new customers. The rule of thumb is that you should spend a third or 33% of your computed Customer Lifetime Value for acquisitions.

If you are spending more, then you must utilize the marketing optimization techniques above to minimize the Customer Acquisition Cost (CAC). If you are spending less, then it means your current marketing strategies are working well and can even be scaled to get you more customers!

How to Improve Customer Lifetime Value

Let’s say you’ve already calculated your CLV and found it to be too low to keep your business running. Don’t give up on your business yet! There are still a few ways to improve it, and these are through:

1. Making Your Onboarding Process Better

If you want to be successful with your customers and steadily grow your business, you have to put a lot of effort into ensuring a great onboarding process. It’s essential that business owners take this seriously as poor onboarding happens to be one of the major causes of a high churn rate or high cart abandonment rate.

When a customer first comes in contact with your business, you will have to make a great positive impression so they remain with your brand.

Depending on the nature of your business, desired outcomes, or needs of your customers, the onboarding process may differ. Nevertheless, there are still some general tips businesses can follow to ensure audience engagement from the start.

Here are a few:

• Make the onboarding process as seamless as possible.

Customers like it fast and easy. You can achieve this by providing guides to walk customers through, tutorials, interactive how-to videos, or any other content that could simplify the process and help customers get what they want.

• Personalize the onboarding process.

You can do this by utilizing the personal data you collected like name and location.

• Highlight the value and savings they get.

You should put your effort into letting buyers know the value of your products or services right from the start to motivate them further to buy.

When you decide on the best onboarding approaches to take, test them thoroughly and observe the customers’ behavior to determine the most suitable option. Just make sure that you settle for an onboarding process that’s straightforward enough for buyers to have a seamless journey.

2. Offer Top-Notch Customer Service

If you want to increase retention and grow your business, then you should ensure you invest enough in providing quality customer service to customers. Even if your product is among the best, customers will leave if your service is poor.

Research has shown that about one-third of customers will most likely leave a brand for its competitors after a single experience of bad customer service. You should ensure your customer service is at its best so that your customers have a good experience and continue to come back to your store.

If you’re wondering how you could offer top-notch customer service to boost customer retention and lifetime value, you could try any of the following methods:

• Monitor social media for customer complaints, requests, or inquiries.
• Offer 24/7 support via live chat, phone, email, or SMS support
• Maintain a knowledge base by offering your customers access to supporting documents like self-service articles, video guides, and tutorials.
• Utilize conversational text messaging to encourage your customers to simply send you a text message for any inquiries or concerns they may have.

3. Build a Healthy Relationship With Your Customers

A good customer relationship is more than just customer service; it involves other aspects where your business and your customers “meet”.

To achieve a good relationship with your customers, you must nurture a healthy bond during every interaction you have with your clients, and throughout the customer journey. A way of nurturing this healthy bond is by making them feel like they are being heard and appreciated.

To do this, you need to learn more about them and so you can try to tap into their emotions and expectations. A good way to learn all of this and deliver on your promises as a business would be by surveys and customer reviews.

You should also monitor your customers by connecting with them from time to time even when you aren’t trying to sell something. A social media presence can help in this aspect. This will help you keep a pulse on their satisfaction with your products or services and help you take action the moment you notice a decrease in satisfaction.

You should put in the most effort in building relationships with your top customer segments, or simply, your VIPs. Make these people feel appreciated as they play very important roles in your business’s success.

Mistakes to Avoid When Calculating or Using Customer Lifetime Value

Customer Lifetime Value can be very profitable, however, if used improperly could result in losses in terms of time and money. To avoid that, you should take note of the common mistakes business owners and marketers make when calculating and using customer lifetime value.

They are as follows:

• Inaccurate Segmentation

It’s important that businesses carry out customer segmentation as customers are not created equal. Understanding the differences among the customer segments you create directly influences your process of acquiring customers and retaining them.

Based on the nature of the business, however, creating customer segments may require some deep analysis to be accurately done. You should know by now that Customer Lifetime Value and segmentation usually go hand in hand. So, any inaccuracies in segmentation could render your CLV calculations and analysis a waste.

The solution to this would be to learn how to segment your customers appropriately. Read our article on Customer Segmentation for e-Commerce for more information.

• Choosing an Unrealistic Customer Lifetime to Calculate With

Sometimes when carrying out the CLV calculations you may have to guess your customer lifetime. This may be because you only just started your business and don’t know your true customer lifetime yet.

Whatever the reason may be for having to guess, know that the number you pick initially doesn’t necessarily have to be accurate as it can still be reevaluated as more data presents itself. However, it is very important that you choose a reasonable number.

For instance, you have a subscription-based business and you estimate a customer lifetime of 24 months. If your customer’s average lifespan is 20 months, then you are close to your estimate and you only need to adjust accordingly. But then if you made an overestimation and most customers drop off only after about five months, then you will find yourself with a CLV that is widely inaccurate.

It’s important that you pick a realistic number for customer lifetime no matter how unimpressive it may be, rather than one you only aspire to achieve. There’s a good chance this value will increase and continue to work on your product and business.

To find a realistic number to start with, research the average in your industry.

• Calculating Customer Lifetime Value Without Customer Segmentation

Some business owners may decide to calculate the customer lifetime value across all their customers. While it’s good to have this information, the effectiveness of customer lifetime value really lies in segmentation. By grouping customers based on different demographic and psychographic factors, you can calculate the customer lifetime value for each segment separately and get very useful information.

If for example, you calculate the CLV of all your customers at $60, you will confidently want to spend up to $20 in acquiring new customers. But then imagine you decided to recalculate the CLV but this time according to segments, and you discover that the customers aged 50 and above have a customer lifetime value of $80 while those aged 21 to 30 have a CLV of just $30.

And when you check, you have been spending $25 each to acquire customers from both segments. For the same cost, you can earn more from focusing on the older customer segment, so it would make sense to focus on that instead.

• Not Recalculating Customer Lifetime Value Regularly

It’s expected that things change from time to time in a business due to certain fluctuations. Your products or services may change as you try out new techniques to improve conversions, communicate with customers, and so many other things.

With all these changes, it’s important to recalculate your customer lifetime value from time to time. And don’t just do this to evaluate your business growth, but also to evaluate what kind of adjustments you need to make. Take for instance this pandemic which affected all kinds of markets and industries differently; you will have to recalculate since many customers and segments would surely have changed their purchasing habits.

As long as you continue to refine your model, you’ll be able to make great decisions for the maintenance and growth of your business.

If you don’t know your CLV yet, time to calculate now!

Statistics show that there is a higher chance of selling to a current customer (between 60% and 70%) than selling to a new customer (between 5% and 20%). It only makes sense to put more effort and resources into retaining and selling to an existing customer base.

The Customer Lifetime Value is a very important metric for business owners who want to succeed, especially those who prefer to adopt a data-driven approach to business improvement. You should, however, note that the CLV strategy shouldn’t be your sole business focus but just part of your approaches.

In trying to improve your customer lifetime value, you will have to think beyond creating good customer service and staying relevant to customers, but also try to see your customers as value-creating partners.

Your mindset towards your customers will surely reflect in the way to relate with them which will have an effect on their value to your business. With the information you get from CLV analysis, you can build a more profitable business by investing in acquiring and keeping more customers who would be of value to your business in the long term.

As you may have noticed, SMS marketing on your eCommerce store can have a huge impact on your CLV — you can use it to establish better customer relationships and increase CLV by getting them to come back to your online store more often than they regularly do! Start your SMS marketing strategy by signing up for a 14-day free trial of WinBack today.

Topics: eCommerce, Best Practices