Understanding the Essentials of Customer Lifetime Value (CLV)
Customer Lifetime Value (CLV), sometimes referred to as CLTV or customer value, is a vital metric in business and marketing.
It represents the total revenue a company can expect from a customer during their entire relationship with the business.
In simple terms, it’s the net profit a company can make from each customer over their lifetime.
Note, that there are many variations and adaptations to these methods, and the specific formula used may depend on the business context and available data.
It’s important to choose the most appropriate method for your particular situation and to ensure that the inputs used in the calculation are accurate and reliable.
|Historic CLV||Average Order Value x Purchase Frequency x Customer Lifespan|
|Predictive CLV||(Average Order Value x Purchase Frequency) x Customer Lifespan|
|Margin CLV||(Average Order Value x Gross Margin Percentage) x Purchase Frequency x Customer Lifespan|
|Contribution CLV||(Average Order Value x Contribution Margin Percentage) x Purchase Frequency x Customer Lifespan|
|Discrete-Time CLV||Sum of (Transaction Revenue – Transaction Cost) / (1+Discount Rate)^t, where t=1 to n, and n is the customer’s lifespan|
|Cohort Analysis CLV||Average Revenue per Customer in Cohort x Average Lifespan of Cohort|
|Probability Model CLV||Probability of customer remaining active x Future Expected Revenue from customer|
It takes into account the customer’s purchases and interactions with the business over time and is used to determine the long-term value of a customer to the business.
CLV is calculated by multiplying the customer value by the average customer lifespan5. This metric is important for businesses to understand because it helps them make decisions about how much to invest in acquiring and retaining customers and how to allocate resources to maximize their long-term profitability.
Importance of CLV in Business
Understanding and improving CLV can have a significant impact on a company’s growth and success. Here are some of the reasons why CLV is essential in business:
- Customer Retention: A high CLV indicates strong customer retention, as it implies that customers continue to make purchases over time. Retaining customers is crucial for businesses since it’s typically more cost-effective than acquiring new ones.
- Customer Acquisition: Knowing the CLV helps businesses determine the appropriate amount to spend on acquiring new customers. By understanding the potential revenue a customer can generate, companies can allocate their marketing budgets more effectively.
- Profitability: CLV is a key indicator of a company’s profitability, as it demonstrates the return on investment (ROI) from each customer. A higher CLV means the business is getting more value from its customers, resulting in increased profit margins.
- Business Growth: By focusing on increasing CLV, companies can boost their revenue without solely relying on new customer acquisition. This strategy allows businesses to grow sustainably over time.
Factors Affecting Customer Lifetime Value
There are several factors that can influence a customer’s lifetime value, such as customer experience, customer loyalty, and customer retention. Additionally, factors like the cost to serve and the effectiveness of marketing strategies can impact CLV.
To calculate CLV, businesses need to consider three main metrics:
- Average Revenue Per User (ARPU): This is the mean amount of revenue generated by a customer over a specific period. It helps businesses understand how much each customer contributes to their income.
- Customer Retention Rate (CRR): This metric measures the percentage of customers who continue to make purchases over time. A high CRR indicates strong customer loyalty and satisfaction.
- Customer Acquisition Cost (CAC): This is the total cost of acquiring a new customer, including marketing and sales expenses. It’s essential to keep CAC as low as possible to maintain profitability.
CLV can be calculated using the formula: CLV = (ARPU * CRR) / (1 + Discount Rate – CRR) – CAC
Strategies to Increase CLV
To increase a customer’s lifetime value, businesses can implement several strategies:
- Enhancing Customer Experience: Providing a seamless and personalised customer experience can lead to increased customer satisfaction, loyalty, and, ultimately, CLV. By understanding and addressing customer preferences and pain points, businesses can create a more enjoyable and efficient buying process.
- Omnichannel Support: Offering support through multiple channels, such as phone, email, live chat, and social media, can cater to customers’ preferences and improve their overall experience. Omnichannel support ensures customers have access to help whenever and however they need it.
- Customer Loyalty Programs: Implementing loyalty programs that reward customers for their continued patronage can encourage repeat purchases and increase CLV. These programs can include discounts, exclusive offers, or top-tier benefits for loyal customers.
- Effective Onboarding Process: Ensuring a seamless onboarding process can help new customers feel more comfortable and confident in their decision to do business with a company. Personalisation and providing extra value during onboarding can lead to higher customer satisfaction and loyalty.
Utilising ERP and CRM Systems for CLV
Enterprise Resource Planning (ERP) and Customer Relationship Management (CRM) systems can help businesses better understand their customers and improve CLV.
These systems provide valuable insights into customer behaviour, preferences, and purchasing history, allowing businesses to tailor their marketing efforts and improve customer retention.
The Role of Social Media in CLV
Social media can play a significant role in improving CLV by fostering customer communication and managing a company’s public image.
Engaging with customers on social media platforms can help businesses address concerns, gather feedback, and build stronger relationships with their customers, ultimately leading to increased loyalty and CLV.
Predictive CLV uses algorithmic processes and historical data to estimate a customer’s future value to a business.
This approach can help businesses identify high-value customers, allocate resources more effectively, and develop targeted marketing strategies to maximise CLV.
Closed-loop feedback involves collecting customer feedback, analysing it, and using the insights to improve products, services, or processes.
By addressing customer concerns and demonstrating that their opinions matter, businesses can reduce unwanted churn and increase CLV.
Cost to Serve
Understanding the cost to serve each customer segment can help businesses make data-driven decisions to optimise their resources and improve CLV.
By analysing overheads, logistics, and contact centre costs, companies can identify areas for improvement and implement cost-saving measures.
Customer Lifetime Value (CLV) is an essential metric for businesses looking to improve customer retention, profitability, and growth.
By understanding the factors affecting CLV, calculating it accurately, and implementing strategies to increase it, businesses can build stronger relationships with their customers and maximise their long-term revenue.
Why is CLV important?
CLV is essential for understanding customer retention, determining customer acquisition costs, improving profitability, and driving business growth.
How is CLV calculated?
By using the formula CLV = (ARPU * CRR) / (1 + Discount Rate – CRR) – CAC, you can calculate the lifetime value of a customer for your business. This can help you understand the profitability of your customer base and make informed decisions about marketing, sales, and customer retention strategies. It’s worth noting that this formula is just one method of calculating CLV and other variations may exist.
What strategies can businesses use to increase CLV?
Strategies to increase CLV include enhancing customer experience, offering omnichannel support, implementing customer loyalty programs, and ensuring an effective onboarding process.
How can social media impact CLV?
Social media can improve CLV by fostering customer communication, managing a company’s public image, and building stronger relationships with customers, ultimately leading to increased loyalty and CLV.