Customer Lifetime Value: How to Calculate, Improve, and Capitalize On It
It may come as a surprise to you, but not all of your customers are created equal. Whether you are running a business or you are a customer yourself, you know some people can provide more revenue for the company. Even better, they can do that without commanding high costs. A savvy entrepreneur knows how to figure out which type of customer to focus and improve on to maximize profit.
If you are an entrepreneur, you know many metrics exist that you should know to help you operate your business. Most people would focus on the cost of goods sold, gross margin, and the like. However, there is one substantial number that you should not forget about: customer lifetime value (CLV).
What is Customer Lifetime Value and Why Should You Care about It?
Customer lifetime value (sometimes just lifetime value or LTV) is used to determine the value of an individual customer in comparison with the rest. CLV defines the amount of profit you can get from a particular customer. It involves the time this person (or another business) remains a client (often in a number of years).
CLV, at its core, tells you the present value that an individual customer can help you generate in the future for his or her transactions with your business.
It may not sound as technical as the other metrics you may have, but this number is essential for your business. You need to know your customer’s value to know how much that particular customer is worth to your company. This way, you can start thinking about how you can pamper these customers, how much to spend to make your business more appealing to them, and how to make sure you keep them. Customer lifetime value helps you stay ahead of the game.
How to Calculate Customer Lifetime Value
Customer lifetime value is a big deal, and the calculations can assist you in making smart decisions or necessary changes to improve how your business performs. You do not have to be a math genius to know how to compute customer lifetime value as there are tools that can help you with this task.
There are two methods for customer lifetime value computation
1. Historic CLV – good CLV
In this method, you get the sum of the total profit from all the purchases of an individual customer.
2. Predictive CLV – an even better CLV
This technique uses predictive analysis in which both previous transactions and different behavioral indicators are calculated. The behaviors should forecast the lifetime value of a particular customer. When you have an accurate equation for this method, the amount you get can become more accurate for the customer with every interaction and purchase.
Here’s a general formula for calculating Customer Lifetime Value:
Annual profit expected from customer x Average duration in years – Cost of customer acquisition
Imagine you are the owner of a local printing shop and you want to know which group of customers is more valuable. Your choice is between small businesses that purchase from you semi-regularly and large firms that make transactions with you just a few times each ear but with huge purchases.
For the first group, you can determine the customer lifetime value with the following points…
- The average number of purchases yearly is 10.
- Their average cost per transaction is $200.
- Based on your calculations, your average gross margin is 41%.
- To market your business for these businesses, you pay $10,000 yearly. Divide that amount by your total number of customers (500), and you get $20. This amount is your direct marketing costs for every customer annually.
- One marketing campaign you have is sending out postcards to people. You discover that for every 100 you send, you obtain two new customers. This indicates that your response rate for acquisition is 2%.
- Acceding to your records, you have done an excellent job at retaining these people, so your average retention rate is 80%.
- Finally, you get the discount rate for this equation, which is 10% since you are feeling quite optimistic about the economy’s future. Note that discount rates are calculated by taking the present value of the future profit you can get from your customer (typically the average annual revenue for a certain number of years) and the current cost of money or the economy itself.
After calculating, you find out that this set of customers has a CLV of $699 for five years.
As for the other group, here are the stats:
- The average number of purchases early is 3.
- The average spend per transaction is $400.
- The average gross margin is 50%.
- When you send your postcards, you get four new customers, so you have 4% as your response rate for acquisition.
- The other elements are the same as the other group.
Upon calculating, you discover that your CLV for the larger businesses is $732, which means they offer more profit for you.
Using the results, you should spend more time with the larger customers. To improve your performance in attracting and retaining them, here are some of the things you can do:
- Feature customers in your content. When you post on your blog or social media, include your followers by putting them in the spotlight. It lets them know they are important to you and that you appreciate them.
- Surprise your fans with something they’re interested in. Learn more about your customers through their social media posts. Find out what they enjoy and send them something you are sure they will love.
- Listen to their advice and give them credit for it. When you take suggestions from other people, it empowers them. At the same time, it motivates them to interact with you and your company even more. For instance, you can create polls and give incentive for participating.
- Solve problems fast. When customers need you, always be there for them. Your customer service crew should know how to talk and solve to your customers.
- Prioritize quality. More important than ever is the quality of your product. If you have the best one and you keep updating it to be even better, you know your customers will stay with you.
If you are running a young business (less than five years), you have limited data. You may find it challenging to calculate CLV. You can start with the basics and use variables that you currently have – even if you do not have as much information as older companies. Later on, you can adjust the numbers and how you compute CLV as your customer and business grow.
How Brands Use CLV to Help Their Businesses
Small and big businesses know that retaining customers is not an easy thing to do. However, it is essential no matter what the size of the company. The following calculated their CLV for a specific group of customers and they improved on them in their own ways:
For the Cloud Alchemist, a liquid-vapor brand from Seattle, their primary strategy in enhancing their CLV is through being approachable. They allow their customers to connect and directly engage with them. The founder admitted that he has talked to some of his customers about the birth of their child, their first house, and even about losing jobs.
Other things they did to improve CLV is to send emails to their customers. Based on a purchase, the customer would receive an email asking for a review of the product and by asking how to improve their service.
Super Hair Pieces
A direct-to-customer store for hair pieces, this company rewards their customers by delivering their products at the best possible prices. At the same time, they are of excellent quality, allowing them to stay competitive at all times.
For Super Hair Pieces, they do not focus on ads; instead, they choose to have new customers through word of mouth. Through providing a loyalty program to their customers where they earn points by spreading the word using social media, the company grew without additional budget needed for ads.
As an online grocery store for spices and other Indian dish ingredients, Swiss Rasoi wanted to catch the attention of their customers and make sure they continue to make transactions with them. They did so by offering unbeatable prices, free delivery, and accessibility to ingredients that are hard to find.
They also provided colorful and attractive images that would appeal to their niche audience. Aside from that, they host a flash sale every month on their Facebook account.
DBDPet is a New Jersey-based reptile specialist company. Aside from selling their products and their existing loyalty rewards program, they also provide reptile-concentrated content, giving interested people on how to care for their pets. Customer loyalty of the company stemmed from their expertise. Through their constant stream of content on Facebook, YouTube, and other social media pages, they keep their customers involved.
Florida Colors Nursery
To improve their CLV, Florida Colors Nursery took advantage of their thought leadership. Once again, social media is a huge part of their success. They posted high-quality photos on Instagram where they built a loyal group of followers. From there, they would share their freshest cultivations and tips to their customers.
They also have a loyalty program where they provide points each time a customer makes a purchase.
After a survey that showed Kindle owners spend about $1,233 yearly for buying items on Amazon, while other customers spend $790 on them. As a result, Amazon paid close attention to customer lifetime value through Amazon Prime. It was developed to have more competitively priced items and increase the lifetime value of their customers.
The members of Amazon Prime spend $1,340 annually according to a 2013 survey. Today, they devote even more money in buying at Amazon.
After some studies and gathering data, BONOBOS discovered that their service-oriented stores called Guideshops bring in more customers with the highest lifetime value. Guideshops is a group of retail outlets that allow men to try on BONOBOS clothing of their choice before ordering online. With the help of insights about which channels attract more of the high-value shoppers enabled the company to increase their predicted customer lifetime value by 20%.
Hear and Play Music
The company provides music lessons and other related services and products. They use automated lead nurturing, which allow them to turn some of their prospects into customers. They targeted specific segments of their clients to become repeat customers.
As many of the products are priced below $100, they invite more music enthusiasts to join their programs because they are more affordable than some of their competition. Also, they use automated messages with personalized content and tone, particularly for their high-value prospects.
With the help of those messages, customer lifetime value increased to 419%. There was also a 67% surge in clickthrough rates and almost 19% increase in lead-to-purchase time.
Although the company has transformed into an online business, they did not rely much on discounts and promotions. To improve their profitability, they turned customer lifetime value to optimize their offers for customers who are projected to expand their revenues and share their experience with their social media friends. The goal is to spread the products through word-of-mouth advertisement, especially to people who are looking for affordable products.
As a result, Crocs saw a 10% increase in their revenue – and that happened without them spending money on promotions.
One of the signs you have a healthy brand is your repeat purchases keep coming from existing customers. Getting new customers is always expensive due to the advertising and other methods you performed to acquire them. If these people do not come back to make another purchase, your ad returns are just steady, not increasing over time.
Improving your customer lifetime value can be about making an effort to put your clients in the limelight or offering something that you know will give them the ultimate convenience. As long as you provide them with something that is hard to replace, they will not forget about you and will keep your business in mind.
- Certain customers can be more valuable to your business than others.
- CLV uses past behavior (and math) to estimate how valuable customers are to your business.
- It helps you refine the amount of ad budget you’re giving to each of your marketing channels.