Customer lifetime value is the total worth to a business of a customer over the whole period of their relationship. It’s an important metric as it costs less to keep existing customers than it does to acquire new ones, so increasing the value of your existing customers is a great way to drive growth.
Knowing the CLV helps businesses develop strategies to acquire new customers and retain existing ones while maintaining profit margins.
CLV is distinct from the Net Promoter Score (NPS) that measures customer loyalty, and CSAT that measures customer satisfaction because it is tangibly linked to revenue rather than a somewhat intangible promise of loyalty and satisfaction.
Why is customer lifetime value important to your business?
Ultimately, you don’t need to get bogged down in complex calculations – you just need to be mindful of the value that a customer provides over their lifetime relationship with you. By understanding the customer experience and measuring feedback at all key touchpoints, you can start to understand the key drivers of CLV.
CLV is a great metric to use when you have a multi-year relationship with a customer – say for a paid TV subscription or mobile phone contract. And it’s good for spotting the early signs of attrition – say, for example, you see spend dropping off after the first year as they use the subscription less and less.
How much are your customers costing you?
CLV goes hand in hand with another important metric – CAC (customer acquisition cost). That’s the money you invest in attracting a new customer, including advertising, marketing, special offers and so on. Customer lifetime value only really makes sense if you also take the CAC into account.
For example, if the CLV of an average coffee shop customer is $1,000 and it costs more than $1,000 to acquire them (via advertising, marketing, offers, etc.) the coffee chain could be losing money unless it pares back its acquisition costs. Another thing to keep a close eye on is the cost of that customer to your business.
Another factor in the equation is Cost to Serve. This is part of the cost of doing business, and it involves everything you do to get the product or service into the customer’s hands and doing what they need it to do. For example, logistics, overheads in your physical location, contact center costs and so on.
Breaking this down by customer can help you understand these costs on a granular level, and dig into details like whether your high CLV customers cost the same as the low ones, and whether some customers are more expensive than others. If the cost of serving an existing customer becomes too high, you may be making a loss despite their seemingly high CLV.
Cost to serve may vary across the customer lifetime, unlike customer acquisition which is a one-off expense. To go back to our paid TV subscription, your cost to serve might be higher in the first year of a contract but gradually drop off the longer the customer stays with you. Thus, if your renewal rates drop, your average cost to serve is likely to rise and cause a drop in profitability.
Understanding these numbers over time and being able to track them side by side is the only way to get a true understanding not only of what’s driving customer spend and loyalty but also what it’s delivering back to the business’s bottom line.
How do you measure customer lifetime value?
If you’ve bought a $40 Christmas tree from the same grower for the last 10 years, your CLV has been $400 – pretty straightforward. But as you can imagine, in bigger companies with more complex products and business models, CLV gets more complicated to calculate.
Some companies don’t attempt to measure CLV, citing the challenges of segregated teams, inadequate systems, and untargeted marketing.
When data from all areas of an organization is integrated however, it becomes easier to calculate CLV.
CLV can be measured in the following way:
- Identify the touchpoints where the customer creates the value
- Integrate records to create the customer journey
- Measure revenue at each touchpoint
- Add together over the lifetime of that customer
Customer lifetime value formula
The simplest formula for measuring CLV is:
Customer revenue per year
Duration of the relationship in years
Total costs of acquiring and serving the customer
This formula is suitable for situations where the figures are likely to remain relatively flat year-on-year, as with the Christmas tree example.
It’s an example of historic CLV – a measure that works by looking back at past events.
You can also calculate predictive CLV. This is an algorithmic process that takes historical data and uses it to make a smart prediction of how long a customer relationship is likely to last and what its value will be.
Here’s a worked example of the customer lifetime value calculation using the simple formula above.
Customer A’s revenue per year = $500
Customer relationship duration = 10 years
Cost of acquisition = $50
Cost to serve = $50 per year ($500 over 10 years)
So the math looks something like this:
$500 x 10 = $5,000
$5,000 – $550 = $4,450
CLV for Customer A = $4,450
But what happens when your customer revenues don’t stay flat year on year, and you need to factor in changes that happen across the customer lifetime?
If this is the case, you need a formula that goes into a little more detail. The traditional customer lifetime value formula fits the bill for many businesses in this position.
Traditional CLV formula
Retention rate / (1+ Rate of discount – Retention rate)
This calculation involves a few additional concepts:
GML – gross margin per customer lifespan
This is the profit you’d expect to make over the average customer lifespan (i.e. the revenue minus your costs)
R – retention rate
The percentage of customers who stay with you over a set time period (as opposed to those that churn during that time)
D – discount rate
A percentage to account for inflation. This is frequently set at 10%.
Let’s take a look at this customer lifetime value calculation in action…
Your company’s GML = $2200
Your customer retention rate = 70%
Discount rate of 10%
1 + 0.70 – 0.1 = 0.4
We divide the retention rate of .70 by 0.4 to get 1.75
We can then multiply that by our GML of $2200.
CLV = 0.44 x 2200
CLV = $3850
How to improve CLV
Customer lifetime value is all about forming a lasting positive connection with your customers. So it naturally follows that the way to boost your CLV figures is to nurture those customer relationships. Here are a few ways of doing that.
Invest in customer experience
Customer experience is made up of every instance of connection between a customer and a brand, including store visits, contact center queries, purchases, product use and even their exposure to advertising and social media. Improving the experience is a business-wide endeavor that’s often addressed using a customer experience management program. This is a process of monitoring, listening and making changes that add up to a lasting improvement in how customers feel and their tendency to be loyal over the long-term.
Start a loyalty program
A loyalty program incentivizes repeat business by offering discounts or benefits in return. It might take the form of a loyalty card or app, or a points system that customers accrue when they make a purchase. Although it’s not a silver bullet for customer retention, a loyalty program can yield great results when it’s planned and executed well. We’ve got plenty of tips for getting your customer loyalty program right.
Recognize and reward your best customers
With your customer experience management program up and running, you’ll already have some ideas about which customers are likely to have the best CLV. You can nurture your relationships with these individuals or groups using targeted marketing and special offers that recognize their loyalty. This could include free expedited shipping, top-tier benefits in your loyalty program, or access to exclusive or pre-release products and services.
Close the loop with unhappy customers
Closed-loop feedback is a powerful way to reduce unwanted churn and turn dissatisfied customers into newly loyal ones. In this model, businesses proactively reach out to detractors or complainants and intervene before issues can escalate and lead to a breakdown of the customer relationship. In many cases, this targeted effort and active listening on the part of the business actually makes the relationship stronger than it was originally. It’s a valuable extension of your customer experience management program.