What is customer lifetime value?
Customer lifetime value, often known as CLTV, is a statistic that shows how much net profit a business may get from a client over the course of their relationship. It considers the customer's first purchase, subsequent transactions, and the typical length of time they have been a customer of the business.
You can assess and comprehend present customer loyalty with the aid of customer lifetime value. Generally speaking, if clients keep coming back to you for purchases, you're doing something right with your company. Additionally, you need to spend less on client acquisition costs the higher the customer lifetime value.
Why is customer lifetime value important to businesses? Why does it matter?
Knowing your customer lifetime value (CLV) and how long a typical customer stays with you will help you make informed decisions based on their spending patterns. This metric can assist in informing your customer acquisition, retention, support, and even product and service quality strategies. There are several benefits to calculating customer lifetime value for various client categories, but the main one is that it facilitates business decision making. Among the many things you may learn from knowing your CLV is:
- The amount of money you can invest in gaining new consumers (CAC) while maintaining a successful business partnership
- The precise amount that a typical consumer will spend over time
- What kinds of products do buyers who appreciate quality want?
- Which products are the most profitable?
- Information regarding the customer journey and attrition rates
How to calculate customer lifetime value?
The customer lifetime value formula is:
Customer Lifetime Value = Customer Value x Average Customer Lifespan.
The CLV result is the revenue a business expects to make from a customer during their entire relationship with them.
Customer value is the average amount of money a client spends with you over a given time frame. It can be computed by multiplying the average frequency of purchases by the average purchase amount.
- Average purchase frequency rate = Total number of purchases in a period / number of customers during that same period
- Average purchase value = Total revenue in a given period / number of purchases over the same period
Average Customer Lifespan: This is the average amount of time a customer stays with your business. You can estimate this based on your historical data.
Using the simple formula below, the customer lifetime value is calculated in this worked example:
The revenue of customer A is £500 annually.
Ten years is the duration of the customer relationship.
Acquisition cost: £50
Serving costs equal £50 annually ($500 over ten years).
The following calculation:
£5,000 (£500 x 10)£4,450 (£5,000 – £550).
Customer A's CLV is £4,450.
What are the benefits of calculating Customer Lifetime Value?
Improved Customer Retention
By concentrating on keeping high-value consumers, firms may strategically manage their resources thanks to CLV. Businesses may customise retention programmes and deliver great customer experiences that foster customer loyalty by identifying the customers who are most likely to produce money over the course of their lifetime. Businesses can also spot possible churn issues by knowing CLV. Businesses can prevent valuable clients from departing by proactively addressing any issues or concerns by analysing customer behaviour and spending habits.
Better Marketing Budget Allocation
Companies can maximise their marketing budgets with the use of CLV. Businesses can optimise return on investment by allocating resources to acquire comparable consumers by selecting the most valuable ones. Additionally, by comprehending CLV, companies can ensure long-term profitability by balancing acquisition costs with projected lifetime value.
Better Customer Segmentation
Businesses can more efficiently segment their consumer base by using CLV data. Businesses can tailor marketing messages and offerings to their target demographic and create more engaging experiences by classifying customers according to their lifetime worth.
For example, e-commerce businesses can utilise CLV to divide their clientele into several groups according to how they often make purchases. They can design customised marketing campaigns for every category, or suggestions based on past purchases and estimated future value for each client. This degree of personalisation raises the possibility of repeat business and brand loyalty while also enhancing the client experience.
What are the limitations of Customer Lifetime Value?
Future Assumptions
CLV predictions are based on historical data and assumptions about the future. Customer behavior can change, and new technologies or trends may emerge that could invalidate those assumptions.
Limited Individual Customer Insights
CLV is best for understanding customer segments or cohorts, not individual customers. It can't tell you exactly how much a specific customer is worth.
Retention Rate Stability
CLV often assumes a stable customer retention rate. This isn't always the case. Retention efforts and market conditions can influence how long customers stay with you.
