For an individual customer, their lifetime value can be calculated with this simple equation:
(Average Order Amount) x (Number of Sales Per Month) x (Lifetime of the Relationship in Years) = Customer Lifetime Value
FINDING THE AVERAGE LIFETIME VALUE
Let’s use the three example customers above to show how this works. Amy, Greg, and Mary’s average order amount per month was $50 + $75 + $30 / 3 = $51.67. Their average retention was 2 + 1.5 + 5 years / 3 = 2.83 years. With these averages calculated, we can find the LTV of the average customer:
$51.67 x 12 months x 2.83 years = $1,754.60
When we look at this new equation, we can see at a glance three overall indicators of the business’s health: How much customers are spending each month, how long they continue to return to the business, and how much each customer is worth to the business on average.
Of course, we can imagine the amount each customer spends on average rising, perhaps $10.
Then the average LTV becomes:
$61.67 x 12 months x 2.83 years = $2,094.31
Marketers beneﬁt from the proliferation of digital data exhaust and better tools to analyze the data. But machines alone cannot build strong relationships with target customers; the care and feeding of relationships require human intervention, as the experiences of these companies attest (see Figure 3). Marketing staff will still add value by hypothesizing what variables to test and what stories to tell, and the most powerful marketing will bring together the machines, metrics and minds.
What Exactly Is Customer Lifetime Value and Why Should You Care?
By John Jantschh
In the marketing world, niche terms and metrics get thrown around frequently, and while there is some jargon that you can just shrug off, there are others that you should pay attention to, which brings me to the topic I’d like to discuss today: Customer Lifetime Value (CLV).
Customer Lifetime Value is the calculation of what a customer might be worth to your business over the course of doing business with you, perhaps over the course of a few years as opposed to a single transaction.
This number might change the way you look at how much you are willing to invest to get each new customer, so as you can see, it’s an important number to follow. Once you understand the lifetime value of a customer, you can determine how much you’re willing to pay in new customer acquisition costs.
For example, if a customer buys a $500 service once every year on average for ten years if you keep them happy you might determine you can invest more in landing and thrilling that customer.
This change in point of view often leads business owners from viewing marketing as an expense to viewing it like the investment it can be. Of course, there are many factors that impact CLV over and above simply measuring it.
Who should care about Customer Lifetime Value
For businesses that offer a customer multiple transactions over time, the concept of Customer Lifetime Value is pretty significant. For businesses such as home builders, who might only work with a customer once in their lifetime, this concept might not seem to matter. Seem being the keyword in that sentence.
In my opinion, the lifetime value of every customer, including those who make a one-time purchase, is unlimited because of the potential for referrals they can make. A happy, single-transaction customer might be a source of business for years because they are likely to talk about your business and recommend you to others. It’s happened to me personally numerous times.
How to calculate Customer Lifetime Value
To get technical:
LTV = Revenue from each paying customer per month, multiplied by Gross Margin, divided by churn (Gross Margin is the amount left over after the cost of goods sold, churn is the percent of people who leave).
Let’s break that down a bit.
Computer your average sale and gross margin of profit – we’ll call this number M (margin)
Determine the average number of sales, transactions, renewals, etc you can expect over some period if you keep your customers happy – we’ll call this number R (repeat, renew)
In simplest terms CLV = M X R
I have a $2,000 product, and on average I make about $500 off of every transaction, and people buy on average 4.75 times over the course of the relationship – it could be said that my CLV = $2,375 or $500 X 4.75
Now, with that number in mind I can make some decisions:
Am I investing enough if acquiring more customers?
Could I find more products and services to sell?
Could I find ways to create more frequent transactions?
Could I find ways to get more referrals from these happy customers?
Should I adjust my current pricing based on generating more sales or more profit?
A few notes for calculations purposes:
Try to establish your baseline CLV # (where it stands today), so you have something to go to work on.
The R # in the equation is a huge variable and can include transactions, renewals, upsells, new products, special offers, etc. It’s the number you can impact the easiest with your marketing efforts.
If you have happy customers, there’s a very good chance 20-25% of them would like to buy more – substantially more – go to work on that and make it a strategic initiative as soon as possible.
Here are some more suggestions on how to think about the relationship between CLV and Customer acquisition cost, as recommended by Jay Abraham, author of Getting Everything You Can Out of All You’ve Got:
Compute your average sale and your profit per sale
Compute how much additional profit a client is worth to you by determining how many times he or she comes back
Compute precisely what a client costs by dividing the marketing budget by the number of clients it produces
Compute the cost of a prospect the same way
Compute how many sales you get for so many prospects (the percentage of prospects who become clients)
Compute the marginal net worth of a client by subtracting the cost to produce (or convert) the client from the profit you expect to earn from the client over the lifetime of his or her patronage
Regardless of how long the average lifetime of your customers is, Customer Lifetime Value helps you determine how much you can spend for acquiring a new customer as well as how much you can spend to keep your current customers.
How to increase Customer Lifetime Value
Here’s why I love this metric – a focus on this North Star kind of number gives you lots of room to look at every aspect of your business because many times this number can increase by simply creating a better customer experience.
To improve your company’s Customer Lifetime Value across the board, you need to take care of your customers and ensure that they are loyal to you. A few ideas to do this include:
Improve customer service – provide your customers with the ultimate customer experience. This will help them to become repeat and loyal customers and will increase your odds of referrals.
Solve your customer’s problems – remember, customers care about their interests, not yours. Make all marketing efforts and outreach client-centric and address their needs and pain points.
Show you know your customers by sending them something they didn’t even know they wanted – this personalization shows that you care and helps to build trust and relationships with your audience.
Listen to what your customers have to say and keep them informed when a change is made based off of their feedback
Provide value even when it’s outside of your wheelhouse (this is why I’m very vocal with the idea of creating a strategic partner network)
Reward loyalty – Make them know how much you appreciate them being brand advocates. You should appreciate all that loyal customers do for you, and it’s important that you show that.
Feature customers in your content or give them shout outs – make them feel special
Essentially, your marketing campaigns should nurture current customers as leads. If your lead nurturing endeavors are successful, then your average LTV should increase. If it isn’t, then you know that you need to make adjustments in your lead nurturing endeavors.
The higher your Customer Lifetime Value is, the better off you are regarding acquisition costs. The high value means customers stick around and maintain a relationship with you, which can lead to consistent referrals moving forward.
Hopefully, based on the information I’ve provided above, you’ve realized that this is a metric that can’t be ignored for all businesses, but especially for small business that need to pay attention to their bottom line.
So, let me ask you, are you tracking Customer Lifetime Value? If not, it’s time you start.