As business owners, we often feel the pressure to just keep building, building, building a customer base. In many cases, this is absolutely correct, as without customers, there would be no business.
At the same time, it’s very important to consider the cost of business and the value each customer brings to your business. It’s very simple to take a look at the money coming in through sales and to look at click through rates increasing and feel a sense of accomplishment, but it is equally important to look at the big picture.
How much are you spending to gain customers, and what value does each customer bring to your business? There’s a term for this calculation: Customer Lifetime Value. You may have seen this abbreviated in different ways: CLV, LTV, CLTV, but the principle behind the Customer Lifetime Value is the same in all cases.
What is CLV and what does it tell me?
Let’s first dig a bit deeper into what the CLV means to a business. In this measurement, “value” is measured strictly by how much a specific customer spends over time.
As you’re likely aware, customers can have a great deal of value in other ways, such as through referrals, leaving great reviews, or encouraging their friends and coworkers to follow your blog or social media page. These are all very valuable to the essence of your business, but CLV strictly calculates how much money a customer spends on your goods or services throughout their relationship with your business.
Now, your business may be designed so that a customer has a very short relationship with your business. That may be something you would like to evaluate further. For most businesses, though, return customers are the lifeblood of sales, and customer retention should have high priority.
One thing that CLV teaches us is that retaining a customer is more valuable to a business than constantly courting new customers.
Think about your current marketing strategy. Between affiliate marketers, bidding for keywords on Google, pay-per-click, and more, what does it cost for you to bring in a new customer?
Compare that, then, to what it costs for a customer to organically remember having a pleasant experience with your company and returning for future purchases. For many new online entrepreneurs, this is a very bring moment of “aha!”
How do I calculate Customer Lifetime Value?
Depending on your business, product, or services, there may be a bit of variation in the calculation, so take into consideration any wild variations in your business model. The basic formula, however, is as follows:
STEP 1: Calculate the average purchase. To do this, divide your annual revenue by the total number of purchases. So, if you had 10 separate purchases totalling $100, the average purchase would be $10.
STEP 2: Calculate the average purchase frequency. Divide the number of purchases over a year by the number of individual customers. So, to continue the example, if there were 10 purchases, but Johnny Q made six of those purchases, that would be 5 individual customers. Average purchase frequency rate would be 2.
STEP 3: Calculate customer value. This is the product of the average purchase value and the average purchase frequency rate. In this example, $10 X 2 = 20
STEP 4: Calculate the average customer lifespan. This is the average number of years a customer will continue to purchase products or services from your company. If you’re a brand new company, this may be a bit difficult. Let’s say that Johnny Q has made purchases for the past two years, and Angie A has been a client for the past four years, and Rita Mae has been a client for three years. In this example, the average customer lifespan is 3 years.
STEP 5: Finally, calculate Customer Lifetime Value. This figure will be the customer value multiplied by the lifespan. If the customer value is 20, as in this example, and the average lifespan of a customer is 3 years, then the CLV will be 6.67.
Obviously, this example is extremely simplified for the purpose of demonstration, but the result is telling. The CLV is what you can expect a customer to contribute to your business over the course of their relationship with your business.
The Better the Customer, the Greater the Value
There are various things the CLV can tell us about our customers. For some, observing a drop in the average customer lifespan can help predict customers’ attention span or interest in a product or service.
It can also be indicative of when it’s time to change things up and reignite interest in your business by sending a call to action to existing customers. It might tell you that customers have become complacent, or that it’s time to do some serious A/B testing to liven things up.
There are other considerations for future business planning that can be pulled out of this metric, as well. For example, the CLV can help you determine how much to allocate towards marketing to new customers versus existing customers.
You can also tailor marketing more accurately towards these segments to keep the excitement going about your product or services. Perhaps it’s time to re-evaluate the product or service to make sure it’s still relevant for your niche.
Customer support and sales reps can also use the CLV to determine how to best cater to customer needs, to discover potential gaps in customer support, and to create a sales funnel that continues to encourage customers to return.
How to use CLV data
As you examine current practices and how they relate to your CLV, there are a few things you can keep in mind to build greater value over a greater lifetime.
First, consider segmenting email lists. While much of the information about sales and blog posts is relevant to all customers, existing customers may need less hand holding, and more information about new products and services, or new ways in which your business can solve their problems.
Try drilling down and tailoring communications to each segment to encourage return business. Also, keep current with sending out special offers or coupon codes to return customers. Send coupons shortly after their purchase, to keep your business fresh in their mind, or special “buy two, get one free” for “VIP” customers.
Thank you emails also go a long way towards customer appreciation, and are another great way to sneak in a “here’s 10% off your next purchase” deal to entice them to return. Lastly, keep content fresh and relevant on websites, email autoresponders, and social media.
Customers receive a lot of information each day, and you want them to remember you! Make sure they have interesting things to look at and fabulous content to digest (and possibly recommend to others!).
Calculating your Customer Lifetime Value is not only a healthy way to track the success of your business and average lifespan of a customer, but can provide very helpful insight into the long-term habits and interests of your customers.
This insight can, in turn, help you modify communications, products, services, and customer experience to encourage additional sales. At the end of the day, a longer customer lifetime and greater value will lead to a healthier, more robust business.