When it comes to measuring the effectiveness of marketing and customer satisfaction, data is king. One of the most important metrics to determining long-term success is measuring customer lifetime value.
What is customer lifetime value (CLV)?
Customer lifetime value is a metric used to understand your customers, it’s a prediction of the value your relationship with your customer can bring to your business.
The CLV is used to predict the future value that the company can generate from marketing efforts. This approach looks at long-term profits and not short-term gains. Many businesses look at the cheapest way to acquire a lot of customers, but those customers aren’t often sticky. With CLV, you think about how to optimize your cost per customer for maximum value rather than minimum cost.
CLV is an efficient strategy that helps with concise budget planning. All customers aren’t equal, and those with a higher CLV bring in more revenue than those with a lower CLV.
It’s no secret that retaining a happy customer is cheaper than acquiring a new one.
Since you can’t be sure how long this relationship will last, you can estimate it and state CLV as a periodic value. Depending on your business it can be set for different time frames, but commonly it’s fixed for a 12 or 24-month period.
Why you should you calculate CLV
The main reason is to measure customer retention. The probability of selling to a new prospective customer is between 5%–20%, but the probability of selling to an existing customer is between 60%–70%. Selling to more repeat customers means significantly more profits.
Sales typically follow the 80/20 rule. 80% of your company’s future revenue will come from just 20% of your existing customers.
Your customers, including existing ones, aren’t equal when it comes to revenue per customer, cost per acquisition, and other metrics. By measuring CLV you can better evaluate how much you should invest in retaining your current customers. Also, it helps your organization to plan further spending and divide your budget between retention and acquisition.
Customer lifetime value provides you with a wealth of relevant information on your users and clients. It allows you to answer crucial questions like:
How much should I spend to acquire a customer?
How much should I invest to retain or win back my customers?
How much time should my sales team spend on customer acquisition?
Are my offers well-suited for my best customers?
Let’s Learn How to Calculate CLV
There are a number of ways to do it, and your choice depends on the resources you have, but for the sake of this blog, we’ll stick to the simplest and most traditional method – Historic CLV.
What is historic CLV? It’s the sum of all the gross profit from a customer’s past purchases. To calculate it you need to add up all the gross profit values up to the last transaction (N) a customer made. If you measure CLV on the basis of net profit, you get the true profit a given client generates.
This involves costs of service, return, marketing, acquisition, and so on. The drawback is that you might have to do some complicated math at the individual level to get the most up-to-date data. Still, gross margin CLV gives you a thorough understanding of your customers’ profitability to date.
In principle, this method is valid if customers share the same preferences and interact in the same way with your brand over roughly the same period of time. What you also need to remember is that calculating historic CLV means putting all your customers, old and new, into the same basket. That might be tricky because they can vary when it comes to behavior and preferences. Differences between clients can affect CLV.
How to Actually Use CLV
Once your CLV calculation is done, you can use this information to determine your marketing and sales strategies. You can use CLV to:
- Segment your customers effectively
- Increase customer retention
- Increase loyalty
- Improve forecasting
- Recognize best customers
What increases CLV in business?
Customer lifetime value is vital in growing your business. It gives you all the information you need to deliver all the information you need to provide engaging customer experiences. CLV can be complex but once you put the metrics into play, you’ll be surprised with all the information you can reveal.
Washington Branch Manager, Assistant Vice President