What Is Customer Lifetime Value or CLV / LTV?
In the most basic sense, lifetime value (LTV) shows how much a customer is worth. With this value, you can find out how much resources you should spend on acquiring and retaining the customer to achieve maximum profitability.
Lifetime value, also called customer lifetime value (CLV), is also a way to estimate the average revenue a customer will generate your business during their “lifetime”. Lifetime value looks beyond the individual transaction and instead focuses on the total amount of money the customer will spend with you during their “lifetime”.
This is where the lifetime value comes into the picture and helps us in the following ways:
- How much budget should you set aside to continue to have them as customers?
- The result will be that you will want to spend significantly more budget on more profitable customers!
- Do you have an optimal budget per marketing channel for customer acquisition?
- Did you acquire the most profitable customers?
Why is it important to know the lifetime value of your customers?
The customer’s lifetime value is an important measure because it represents the maximum amount you can spend on acquiring and processing new customers.
In this way, it is a value you can use as a starting point when you make various financial decisions regarding, for example, marketing, search engine optimization and other resource allocation.
If you only focus on the revenue that a customer generates with each individual purchase or visit, there is a risk that you make the wrong strategic decision regarding, for example, marketing and SEO.
In fact, the marketing campaign or SEO venture can in fact lead to a profitable long-term relationship with increased customer loyalty, even if in the short term it seems that the venture is in vain.
Advantages and Disadvantages of Calculating Customer Lifetime Value (CLV / LTV)
CLV is a great method to use to estimate your marketing budget to create a new customer. CLV helps you balance your marketing budget based on your own customers.
Benefits of CLV / LTV
The benefits of using lifetime value are to optimize long-term profitability instead of limiting it to short-term profitability on a monthly or quarterly basis.
This makes the company more profitable over time, given the company’s specific customers and business. Using CLV also gives you the opportunity to start managing your customers as an asset.
It will also be easier to derive the effectiveness of different strategies linked to marketing activities.
Disadvantages of CLV / LTV
The disadvantages of using CLV are that it can be more difficult and time consuming to calculate. As a rule, the disadvantages consist of calculation errors or that the wrong model is applied in the wrong way.
A typical mistake is not to take into account the different types of customers that exist; smaller, medium or very profitable customer types, segmented by channel, product or service.
Here, the weighting between different customer types is also missed as they are not evenly distributed in the company if only average profitability is used.
Worth adding is that this is not a one-time calculation. When any of the variables or constants in the equation changes markedly, increases or decreases, new calculations should be made.
How often this happens you need to keep track of through your key figures for the equation.
To try to minimize the error steps, I go through the most necessary steps in two methods.
The first method is more descriptive and slightly less computationally focused. The second method goes deeper into how you can count in three different ways.
The calculations are not exhaustive in any way, but these are the three most common ones I have encountered.
CLV / LTV leads to valuable insights
By calculating customers’ lifetime value, you can gain valuable insights that will help you run your business more efficiently and profitably.
Lifetime value can for example:
- show which marketing activities you should invest in relation to where the customer is in the sales funnel.
- show if you have an optimal budget for customer acquisition.
- show how much money you should set aside to retain your customers.
- help you calculate how long it takes to get back the investment you made to get a new customer.
- help you determine the value of your conversion goals.
- tell you when a customer becomes profitable.
- give you an indication of whether you have acquired the most profitable customers.
- show when to carry out various marketing and SEO activities.
CLV / LTV: Some things to keep in mind
- CVs will vary from month to month (and of course you want the value to go up over time); if your Customer Value goes down, it may be due to increased churn, that some of your products have become cheaper from a competitor, that customers buy products with a lower margin, that the new site does not encourage additional sales, etc. etc. Change of CV over time is an excellent “high level” indicator of how the business is doing, and a good starting point for further analysis.
- A newly started business cannot calculate Customer Value. To be able to calculate a CV for 12 months, you need to have had customers for at least 12 months. To be able to calculate a CV for 5 years, you need to have had customers for at least 5 years.
- A certain number of customers is needed to calculate the CV. Thousands of new customers every month, provides a much more stable and credible KPI than if you have 10 new customers every month.
Lifetime value for conversion optimization
Lifetime value is especially rewarding in conversion optimization as it can be used to decide which goals to invest in. By calculating the lifetime value of a customer, you can assign a value to each conversion in the sales funnel.
In this way, you can get a more accurate picture of each conversion in relation to the customer’s LTV than if you only start from the first conversion.
This method thus makes it easier for you to create a correct marketing budget and get customers to move where you want.
CLV / LTV: Segment customers
Customer Value can be very powerful when you apply it to different customer segments. Simple demographic variables such as gender and age are a good start.
I recommend all B2C companies to calculate resumes for different age groups; the craze for younger customers can usually be dampened somewhat when you realize that young people lack money…
The sales / marketing channel through which the customer has been recruited can also be of great importance for its value over time.
Do not be surprised if customers who are attracted with premiums have a lower CV compared to customers who found you via Google.
When you add the “CAC” to that insight, you find it easier to focus on a long-term SEO strategy instead of a short-term Give aways strategy.
Calculate lifetime value – step by step
Step 1 – Calculate the average revenue per customer
Net sales (during selected period) / average number of customers (during the same period)
Step 2 – calculate gross profit per customer
Average revenue per customer x average gross margin.
Step 3 – calculate monthly churn rate (customer turnover)
The purpose of calculating the churn rate is to find out what percentage (percent) of customers you lost during the period.
Number of lost customers / ((number of customers at the beginning of the month + number of customers at the end of the month) / 2)
If you have limited historical data, you can convert your monthly churn rate to annual churn rate using the following formula.
1 – (1 – monthly churn rate) ^ 12
Step 4 – calculate average customer life (number of years)
1 / annual churn rate in decimal form
Step 5 – calculate lifetime value
Average gross profit per customer and year x average customer life (years)
Calculate the net worth of a customer throughout its life.
Lifetime value – average cost of acquiring a new customer
Here are 5 tips on how to retain your customer and build a strong relationship:
- Clear areas of responsibility internally at the company. The sales department works hard to get the customers in, but who makes sure that they stay too?
- Never ever compromise on your customer promise. Never forget the promise you made when you sold your product / service.
- Clear processes with the customer to ensure the quality of the delivery. Make a strategy for how you will deliver and always evaluate your delivery. With today’s technology and highly developed CRM systems, you can match the customer’s needs at the individual level.
- Be available and communicate with customers continuously. Regardless of the type of product / service you offer, you should always be on hand for any questions or dissatisfaction.
- Offer regular and customer-friendly information with exclusive benefits for your customers. Newsletters / membership letters are an easy way to do this, even loyalty programs. With these, you can partly share knowledge about your product, but also create campaigns with specific offers for your members / customers.
Not to forget, with a good CRM system in place, you can solve many of the parts completely automatically. So, now is the time to review your existing customers, identify their needs and increase their Customer Lifetime Value. Go for it!