Do you know how to calculate customer lifetime value? As a business owner, it is important to understand the experience of your customers and how these relationships can impact your bottom line.
The relationship between a customer and an organization, business or product can highlight important indicators of the success of a business’s customer management and experience.
Today, we’ll discuss how to calculate customer lifetime value and how this metric can help guide your business model in the future.
Here’s what we’ll cover:
What Is Customer Lifetime Value?
Customer Lifetime Value (CLV) is the total value of a customer’s relationship with a business over the whole period of their relationship. In plain terms, this simply means the worth a customer represents in their relationship with a business – purchases made, customer loyalty etc.
CLV is an important metric for any business as it is more cost-effective to retain existing customers than it is to constantly attract new customers.
This is particularly true for small businesses, businesses in a competitive industry or businesses that represent a niche product or market.
For many businesses, the attracting of new customers can often overpower the strategies of marketing efforts when in fact increasing the value of current customers is often a more effective way to drive growth and revenue.
It is important to note that CLV is a critical measure of a customer’s relationship with your business but it is not the only metric that can be used to determine the value of your customer retention model.
CLV is a distinct measurement from the Net Promoter Score (NPS), a metric that measures customer loyalty and satisfaction based on revenue generated.
How to Calculate Customer Lifetime Value?
Customer Lifetime Value is a fairly straightforward calculation but measuring CLV can often be fairly simple or impossibly complicated based on a number of factors.
For larger and more complex organizations, inadequate customer tracking and a lack of integration between targeted marketing campaigns can make the calculation of CLV can be extremely difficult.
CLV is calculated by adding critical data points together and expanding that measurement over the course of a customer’s relationship with your business or brand. There are a number of metrics to consider when examining a customer’s value to your brand, primarily their touchpoints where they create value (purchases, referrals etc.).
Based on what your business values this could mean social media metrics, purchases of a certain product or service, repeat bookings or purchases on a consistent schedule, their ability to refer new customers etc.
To calculate CLV, there are two other important data measurements to factor in.
The primary metric is the costs associated with attracting new customers through various marketing efforts.
This type of calculation is called Customer Acquisition Cost or CAC. CAC could include costs such as targeted social media and marketing campaigns for new customers, new customer promotional offers and new customer advertising.
The other metric used to calculate CLV is the Cost to Serve measurement. This is the total cost associated with managing existing customers including ongoing marketing efforts and all other costs necessary to get the products to your customers. The Cost to Serve cost includes business operations costs such as your physical location or storefront, shipping costs, staffing costs and other logistics.
Once you have identified these two contributing data metrics, the CLV measurement can broken down into a simple calculation:
How to Calculate Customer Lifetime Value
Customer revenue per year multiplied by the duration of years as a customer minus total costs of acquisition and serving the customer equals CLV
(Customer revenue/year) x (number of years as a customer) – (Customer Acquisition Cost + Cost to Serve) = Customer Lifetime Value
While this calculation may seem simple, it can be extremely difficult to integrate customer data comprehensively enough to capture an accurate picture of a customer’s lifetime value.
It is important to consider these types of metrics when developing your business model, especially as your experience periods of growth and additional customer acquisitions.
An example of calculating CLV
Customer A’s revenue per year to Company B is $1000 a year
The customer relationship between Customer A and Company B is 10 years
Cost of acquisition of Customer A = $100
Company B’s Cost to Serve = $100 a year ($1,000 over 10 years)
1,000×10 = $10,000
$10,000-$1,100 = $8,900
So, therefore, Customer A’s CLV to Company B is $8,900
How to Increase Your Customer Lifetime Value
The positive connection with your customers can often have profound formal and informal impacts on your business. Informal impacts can include an engaged community of followers on social media.
Formal impacts would include data on customer purchasing habits and the ability of existing customers to leverage and attract new customers. A high Customer Lifetime Value for the majority of your consumers is a vital success measure in the effectiveness of your business model and customer service initiatives.
However, what do you do if your brand or business does not have a high CLV?
Are you able to increase customer loyalty?
The simple answer is YES, and there are a number of subtle strategies to do so in a way that customers may not even consciously notice.
Customer experience is key
Understanding your customer’s experience with your brand is critical in helping to identify ways to elevate your CLV. The connection between a customer and a business is all-encompassing and should be integrated and considered at all levels of your business.
A customer may based their opinion of your brand through customer experiences such as:
- Visiting a store-front or physical location
- Accessing customer service through face-to-face contact, call centres or online
- Exposure to marketing and targeted advertising
- Experience online through social media channels and website usage
FAQ pages are a great resource for customers to find the answers they need promptly and efficiently, but creating one isn’t as easy as you might think. Read our FAQ Page Guide for the full details and templates that you can use.
To improve your customer experience, and by extension strengthening your customer lifetime value, it is important to identify gaps and potentially negative issues for customers in all elements of your business.
If you conduct the majority of your business online, social media and web analytics can be particularly beneficial to map out your customer experience online. Through these analytics, you can identify where and how customers interact with you online.
Address customer service concerns quickly and effectively
While it is important to identify ways to positively impact your customer experience model, it is also important to take a critical look at the negative ways your business may interact with customers.
These negative experiences can create dissatisfied customers and if this type of dissatisfaction happens often enough, can negatively impact your businesses’ ability to retain loyal customers and a high CLV.
A practice called Closed-Loop Feedback is a way to convert formerly dissatisfied customers into loyal customers through positive customer service experience and a method of intervention to address issues before they lead to the breakdown of a customer relationship.
This type of active listening and targeted conflict resolution is a valuable way to retain customers and increase your overall CLV.
Another way to increase the Customer Lifetime Value of your customers is to reward loyalty through a number of different initiatives.
This type of customer experience management plan identifies and rewards your best customers through loyalty programs such as a loyalty card or app, referral programs, discounts or points accrued through a purchases program.
It is important to remember that customers are often motivated by savings and the potential for special offers or promotions, so often these types of benefits can encourage customer loyalty and an increased CLV for a larger majority of customers.
Understanding and knowing how to calculate Customer Lifetime Value is a critical measurement of success for your business and your business and customer experience models. The formula for how to calculate customer lifetime value may look simple at first, but finding enough relevant, high-quality data to paint a comprehensive picture of a customer’s true lifetime value is difficult.
There are many approaches when it comes to learning how to calculate customer lifetime value – different methods may employ different data points and different metrics but at the end of the day, the function of the calculation no matter the formula is to determine how much a potential customer is worth to your business over their lifetime of interaction with you.
It is more cost-effective to grow and maintain your business by continuing to prioritize the experience of your existing customers rather than always investing in attracting new customers. A high Customer Lifetime Value is critical for sustaining business growth and predictable revenue year over year.