What is Customer Lifetime Value and Why Is It Important?

By Peter Luis Venero in Entrepreneurship

on August 3rd, 2021

What is CLV (Customer Lifetime Value)?

Customer Lifetime Value (or CLV) is the amount of money a customer is estimated to spend with your business for the life of your relationship with that customer. CLV is an important metric, and the way you approach it can both define your business and could vary significantly depending on what you’re trying to get from your business.

CLV is a measurement of how valuable a customer is to your business over time, so keep in mind that your initial interaction is more than just a simple exchange of goods for money. Of course, not all customers are valued equally, and because it’s far more expensive to find new customers than to keep your good existing ones, keeping your CLV high can be essential to the success of your business. After all, a higher CLV means that you have more loyal customers because they stayed with you for longer.

Why CLV is the life force of your business

Customer Lifetime Value determines the financial value of each of your customers. In and of itself, that’s an important purpose. But CLV is also unique in that it can look forward, as opposed to a concept like customer profitability, which measures past activities in order to gain insights. Much like you should always be looking into the future to determine which products you should sell, various ways you can optimize your business, and how you might serve your customers better, CLV can forecast future activity to improve your bottom line.

So, what can you do with Customer Lifetime Value? And why should you care?

Advantages of CLV

Specific advantages of understanding Customer Lifetime Value include:

  • CLV allows you to measure the financial impact of marketing campaigns, initiatives, and other activities.
  • That, in turn, will help your company align and ladder up to bigger financial targets in an organization—or start creating them if you’re a smaller operation.
  • CLV can also change the way you think about marketing in terms of creating loyalty objectives or focusing spend on underutilized areas.
  • CLV will help you find balance in terms of short-term and long-term marketing goals and demonstrate a better understanding of financial return on your investments.
  • CLV encourages better decision making by teaching marketers to spend less time acquiring customers with lower value.
  • And the bottom line? Effective management of your customers relationships, which leads to increased profitability—that’s perhaps the most obvious advantage of Customer Lifetime Value.

In conclusion, when considering why you should spend more time learning about Customer Lifetime Value, it’s important to keep in mind the literal value of a customer. It makes sense to invest marketing spend toward implementing customer lifetime value because your customers are especially valuable and great attention must be paid.

How to calculate CLV

So, how do you actually calculate CLV? You can estimate your Customer Lifetime Value with the following steps:

  • Forecast a customer’s lifecycle with your business
  • Estimate future products or services purchased by your customer to forecast future revenues
  • Estimate your costs associated with producing and delivering future products
  • Calculate the current value of those revenue amounts

While the process is not exactly suited for the right-brainers, breaking it down into chunkable steps can help.

Here’s an easy chunked-out formula to calculating your customer lifetime value

In order to determine your CLV, you’ll need a few things:

  1. Step 1 – determine the average purchase value: Divide your company’s total revenue in a time period by the number of purchases in that same period. 
  2. Step 2 – determine your average purchase frequency rate: Find out what the average amount of orders from each customer are.
  3. Step 3 – determine your customer value: Determine this number by multiplying your first two calculations: average purchase and average purchase frequency.
  4. Step 4 – determine your customer lifespan: This is the length of time a customer relationship typically lasts before that customer disengages from your business.
  5. Step 5 – determine your forecast revenue: Using the information you’ve determined in the first 4 steps, you can estimate how much revenue you can expect from an average customer. Simply multiply the customer value by the average customer lifespan.

For a real-life example, try this Starbucks case study. From Neil Patel Digital:

“It’s no secret that Starbucks’ acquisition strategy is closely scrutinized and routinely copied. Using rough sales figures from 2004, we’re able to estimate the CLV of an average Starbucks customer.” 

You’ll most likely be surprised at what the CLV is for Starbucks, and why they’re so extra friendly to all of their customers.

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