Customer Lifetime Value or CLV is a metric in marketing which represents the total profit a company makes from a single customer account over the entire lifespan of that account, and takes into consideration changing market conditions and future strategic plans.
This is a VERY important metric (The Golden Metric: Customer Lifetime Value) because it helps us determine how much repeat business we can expect from an existing customer in the future. This helps us to forecast future revenue as well as how much to squeeze the account for future sales. Typically CLV is calculated after you have a solid understanding of your relationship with the customer and their buyer persona.
Please note, CLV is quite different from customer profitability (CP), which strives to measure a customer’s overall worth to the company in a fixed period of time, usually the last several buying cycles. Basically CLV measures the future while CP measures the past. To truly understand your CLV, you may have to delve into the world of Big Data Marketing and figure out what information you have that is usable.
Why is Customer Lifetime Value (CLV) important?
1. Helps generate the correct ROI for customer acquisitions
With CLV, you can identify the main channels which generate the most traffic. By using CLV, you will notice that you suddenly have a lot more to spend in order to acquire new customers. This is because with CLV, you won’t be looking at the amount of profit generated in a single purchase, but you will be looking at the total number of purchases made during the lifetime.
2. Better, targeted marketing
CLV can help segment your customer base and target each one differently by sending out personalized messages. Some of your products might be doing better than the others but that does not mean that all of your customers want the same products.
If you are marketing your products to all the demographics, then you are wasting budget on generic audiences that are not interested. It’s time to tighten up and focus!
3. Identifies behavioral triggers
By evaluating CLV, you can understand what triggers customers to make their first purchase. Once you have a solid understanding of their point of entry, you can replicate the same behavioral triggers and turn your prospective customers into first time buyers.
4. Pay special attention to your most valued customers
If you are not familiar with Pareto’s principle, I’m sure you’ve heard it a thousand times – 20% of your customers bring in 80% of the revenue. Similarly 20% of effort, or targeting, could yield 80% of your return on marketing investment (ROMI).
With CLV you can identify those 20% of your customers that are the most valuable and the most profitable as well. Paying attention to your most important customers and building strong relationships with them will help push your profit margins!
5. Better retention strategy
Your marketing strategy shouldn’t just be about the number of one-time buyers you are able to attain, unless you are in a sell and burn business, B2B marketers strive to retain a loyal customer base over the long haul. Consider this when you start factoring in CLV into your marketing measurement mix.
How to calculate CLV
There are two ways to calculate CLV – the old school CP style and the new school predictive style. Some Companies even sum a variety of CLV models and take the average – the choice is yours!
1. Historic Old School CLV
This can be simply calculated by summing together all the transactions made by a customer and dividing it by the total number of transactions.
But this process isn’t used by the major brands anymore. This is because the historic CLV formula only compares the total purchases a customer has made but it doesn’t take into account how advertising and marketing practices have changed over time. The fact is – new millennial customers behave differently than the old ones and changes to any of the go to market strategies could also lead to a change in the client base.
CLV = (Cost of Transaction 1 + Cost of Transaction 2 + …..+Cost of Transaction N) × margin
2. Predictive CLV
This gives a more accurate value of CLV by predicating the average revenue a customer will give to your brand. But at the same time, predictive CLV isn’t as easy to calculate. Usually, brands use several different variations of the CLV equations.
Here is a predictive CLV equation:
CLV = Time * (Margin * (Yearly Transactions * Order Value))
Very Simple Example
Take a car company for example, if we think about the typical customer that buys a car, we can frame this scenario in some real world terms.
Let’s say our customer, we’ll call her Mrs. X, typically buys a new car every 5 years. This means her average purchase per year, is roughly 0.2.
Mrs. X is also a fairly thrifty consumer and prefers modest sedans and compacts. Let’s say she spends on average $20,000 for every vehicle she buys.
If Mrs. X is currently 30 years old, she will probably be driving until she is around 80, so let’s suppose she has 50 years left of consumer opportunity.
Lastly, margin. The average gross margin of a new car is around 8% for the dealer.
So, now that we have all the ingredients together, let’s cook up some CLV math:
CLV = Time * (Margin * (Yearly Transactions * Order Value)) CLV = 50 years * (8% * (0.2 * $20,000)) CLV = 50 years * (8% * $4000) CLV = 50 years * $320 CLV = $16,000 of gross profit
Now we did state that this was gross profit, so we have not taken factors such as the following into the calculation:
- Client retention rate
- Net Present Value (NPV) of the dollar
- Cost to acquire and service the customer (e.g. marketing costs)
In order to really model this in a real world setting, you would need to factor these considerations into the equation. In order to help you out on your journey, you could visit the Harvard Business School website where they have a handy Customer Lifetime Value Calculator for you to use and model your own economic situation.
The more you tailor your CLV equation according to the specific industry you are in, the more accurate it will be. Customer Lifetime Value is an important metric to understand how valuable your customers really are. Understand that the more accurate your CLV is, the more powerful your overall marketing efforts will become.