Customer Lifetime Value: What it is, How to Calculate it & Why it Matters
Customer lifetime value (CLV) is just another way to say how much money a customer will spend throughout their relationship with your business. It can also be referred to as CLTV or LTV. CLV is directly tied to your eCommerce business’ revenue, as it is used as a metric that is employed to analyze historical customer behaviors and predict future behavior.
It is important to understand CLV when determining how much money should be spent in retaining current customers vs how much should be spent acquiring new customers. Typical e-commerce businesses profit more from returning customers than they do new customers. The ability to convert a new customer is only 5-20%, whereas the ability to convert an existing customer is upwards of 60%. The goal for any business is to ultimately optimize this conversion rate.
The longer a customer uses or buys from a certain company, the higher their CLV becomes. Customer experience directly affects a customer’s decision to buy and create profit for the company. Before we discuss how to improve CLV through the customer experience, we must learn how to calculate an individual customer’s lifetime value.
The Formula for Individual Customer Lifetime Value
To calculate a customer’s lifetime value you need to know how much your customers purchase, how often, and their general overhead costs. The CLV formula has 3 components that you will need to understand, these include:
- Purchase Value: The amount charged to the customer per order
- Purchase Frequency: How often the customer places an order
- Average Customer Duration: The amount of time a customer actively purchases from the business
Now that you have the definitions of those terms it will be easier to understand the formula for individual CLV.
The formula for calculating individual customer lifetime value is:
Purchase Value x Purchase Frequency x Purchase Duration = Customer Lifetime Value
Here is an example of how this formula would work when determining the CLV of a customer of your website.
- The customer places an order for a $100 item ($100 purchase value).
- The customer places a $100 order four times a year. (purchase frequency = 4x annually).
- For the past four years, the customer has consistently purchased this product (average customer duration = four years).
- $100 x 4 x 4 = $1,600 (Individual Customer Lifetime Value).
Use this individual CLV calculator to easily calculate your individual customer’s CLV.
How to Find Your Company’s Average CLV
Every company will have a different average CLV. This is the average of what value a customer brings to your business over the course of their relationship with your business. To determine this average, you will need to know the totals and averages of orders, revenue, and the number of customers per period (typically a period is one year).
The formula for calculating a company’s average CLV is pretty simple, but there are several components you must understand first.
- Average Purchase Value: Calculate this number by dividing one year’s total revenue by the number of orders that year.
Total Revenue / Number of Orders = Average Purchase Value
- Average Frequency Rate: With the same timeframe in mind, divide the number of orders by the number of unique customers.
Number of Purchases / Number of Customers = Average Frequency Rate
- Customer Value: This number is found by multiplying the average purchase value by the average frequency rate.
Average Purchase Value x Average Frequency Rate = Customer Value
- Average Customer Lifespan: Calculate this number by averaging the amount of time a customer continues to purchase from your business. Use the same measurement of time as you did for calculating customer value.
Sum of Customers Lifespans / Number of Customers = Average Customer Lifespan
- Company’s Average Customer Lifetime Value: To get your company’s average CLV, you will multiply your customer value by your average customer lifespan. You can do this by hand or use an average CLV calculator.
Why CLV Matters to Businesses
Why does CLV even matter to your business? CLV can help you determine how to spend your businesses’ funds and show you what customers you should really be targeting. Let’s take a look at ways knowing CLV can improve your business.
1. Retaining vs. Acquiring Customers
Knowing your customer lifetime value will help you allocate funds towards current customers or attracting new customers. If your CLV is low for returning customers, possibly put more funds into marketing for new customers. This often happens with eCommerce businesses that sell clothing or “one and done” goods that don’t necessarily need replacements.
2. Review and Predict Revenue
CLV can help you predict what your company’s future revenue will be. Knowing the value that your customers bring and how often they spend money will give you a good idea of how much and when your company will be gaining the most revenue. This will help your buyers and/or warehouse know when the best time is to purchase or make more products as well.
3. Calculate Products’ ROI
Knowing your company’s CLV can help you calculate which products have the highest and lowest profitability margins. You can see which products customers spend the most money on and continue to purchase these products that have a high return on investment, rather than products that sell slower and make less profit.
4. Narrow Target Audience
CLV can help you pinpoint who your most profitable customers are, as it shows who is spending the most money on your products. Knowing your target audience and advertising towards them, rather than a vast group, will help you save money on marketing.
How to Improve Customer Lifetime Value
Calculating your business’ average CLV is just a starting point. If your value is lower than what you were expecting, there are some changes you can make to improve your average CLV. A business must look at its overall customer experience and customer satisfaction rates when trying to boost its CLV, as these are often the determining factors in a customer’s lifetime value.
Here are some ways to improve the customer experience, therefore boosting your potential for a higher average CLV.
1. Customer Complaints
Often, if your business gets a complaint from one customer, odds are many other customers are also thinking the same. Customers will often switch to shopping from a competitor if they feel their needs aren’t being adequately met.
With eCommerce stores, complaints range widely from a slow platform to a lack of customer support. Many of these complaints are easy fixes. Address these complaints to create a better customer experience and to increase the customer satisfaction rate.
A great way to know what your customers are thinking is to not only analyze the quantitative data they give you by purchasing but to also use surveys to back up customer’s feelings with qualitative data.
A quick pop-up advertisement after the customer checks out on your eCommerce website or an email asking for their opinions should suffice. At the end of the day, you will always know something more about your customers than you did at the beginning of the day.
3. Retention Rates
Acquiring a new customer is up to 25 times more expensive than retaining an existing one. Retaining customers is extremely important, as it will save your company more money on marketing and promotions.
CLV helps determine at what point in the cycle of a customer’s relationship with your business they start and stop buying. You can look at what was happening in your store at the times they bought (possibly, a huge sale) and what was happening in your store at the time they were no longer buying (perhaps, the website speed was slower than normal). Fixing these problems and continuing the strategies that draw in customers will help boost your customer’s experience.
Quick CLV Boosts and Strategies
These strategies are lower effort than most but have shown quick results when done properly. They don’t require extra work and can often be as simple as adding an app to your eCommerce platform.
1. Contact Customers with Abandoned Checkouts
Many eCommerce platforms have this as a free application that will automatically send emails to customers that have abandoned their checkouts. This will lead to higher conversion rates, especially if the retention email has a discount code in it. It is as simple as downloading the application and/or setting it up!
2. Create a Rewards Program
Rewards programs are a great way to encourage customers to continue shopping at your store. Stores such as Kohl’s and Old Navy have perfected their rewards programs and it continues to draw people back to their store.
Giving discounts and coupons for their next purchase will keep customers returning (often, spending more than what their coupon was worth). Many stores will use “cash” to keep customers coming back. This is a method in which the store gives a customer a voucher for a dollar amount off their next purchase, but the customer only has certain days of the month they can use this cash. This is a repeating cycle that keeps customers on their toes and returning to the store.
3. Upsell Your Products
Upselling is a technique that persuades customers to purchase more expensive items, upgrades, or bundle packages in order to generate more revenue. It ultimately makes your items more valuable to customers and more likely to be purchased at a higher price.
A common upselling tactic is offering customized services when a person spends a certain amount of money on your website, such as early access to your next collection or exclusive access to a community Facebook group.
4. Increase Order Sizes with BOGO Sales
Increasing UPT (units per transaction), will ultimately increase your customer’s lifetime value. A great way to do this is having BOGO (buy one get one) sales. This will lead your customers to make bigger transactions to avoid missing out on a deal, even if they don’t really need the extra products at the time of purchase. This is a great way to not only draw customers’ attention but get them spending!
Calculating individual and average customer lifetime value will greatly benefit your business. Knowing your loyal customers and how much they are spending on your goods and services will help you better allocate your funds and understand who your target audience should be. Overall, your business will only come better by improving CLV, as it will force you to also improve your overall customer experience and satisfaction rates.
Use Your Customer Lifetime Value To Your Advantage
Customer lifetime value is a seriously useful metric. It tells you which customers spend the most at your business and which ones will remain loyal to you for the longest amount of time. Use the formulas and model provided above and start calculating CLTV for your business today.
Chi Whitley is a content marketer based in Austin, TX for B2B and B2C companies. When not brainstorming ideas or generating content, you can find him throwing a frisbee or hiking with his dog, Augie.