Defining and Measuring Customer Lifetime Value
The Key to Unlocking Sustained Growth
The Importance of CLV
For a company, there are many ways to measure customer value — from average order value to conversion rates.
But none is perhaps as important as Customer Lifetime Value (CLV). A customer’s lifetime value measures how valuable a customer is to a company over the course of their entire relationship, instead of on a transaction-by-transaction basis.
As many executives know, it’s five times more expensive to attract a new customer than keep an existing one. The same survey shows that the probability of selling to an existing customer is 60–70%, compared to 5–20% for new customers. Previous customers are also 50% more likely to try new products, and 31% more likely to spend more (Invesp).
It’s no surprise, then, that focusing on loyalty and retention is a way to drive significant growth. However, far too many companies focus on acquiring new customers instead of retaining existing customers. They strive to make the prospective customer’s experience excellent through the moment of purchase but don’t place as much emphasis on delivering a delightful delivery, usage, and repurchase experience to drive advocacy and loyalty.
CLV vs. CAC
Knowing their Customer Lifetime Value helps businesses balance acquisition and retention efforts while maintaining profit margins.
In this balance, it’s also important for companies to consider their Customer Acquisition Cost (CAC). According to Qualtrics, “CAC is the money invested in attracting a new customer — including advertising, marketing, special offers and so on.”
CLV can help a company determine and stick to an acceptable CAC. For example, if a company is spending $100 to acquire a new customer (CAC), but their CLV is $75, then the organization is losing money and needs to lessen its acquisition costs.
Calculating CLV the Easy Way
There also may be differing CLVs for various customer types. This is where target audiences come into play. Your Target Audiences are typically the customers who have proven to have the highest CLV. Perhaps other customer types fall into your funnel, but their CLV is lesser. Therefore, organizations should focus on spending where it counts.
Tracking CLV can be a bit tricky — particularly for organizations without a centralized data system. The easiest formula for measuring CLV is:
Yearly Customer Revenue
x
Duration of Relationship in Years
—
Total costs of acquiring and serving the customer
=
CLV
This is an example of historic CLV — a CLV calculated based upon examining past events. For many companies, this is sufficient to gain an actionable understanding and strategize accordingly.
With that said, companies can also calculate predictive CLV. This takes the equation above and, instead of leveraging historic numbers, it factors in predictive estimates to get a predictive CLV.
Calculating CLV the Traditional Way
However, for some companies, they need a way to calculate CLV that goes into a bit more detail and factor in variations that happen across a customer’s lifecycle.
In this case, the following model for calculating CLV is often preferred:
Gross Margin Per Customer Lifespan
x
Retention Rate / (1+Rate of Discount — Retention Rate)
Gross Margin Per Customer Lifespan is the profit that a company would expect to generate over an average customer lifespan (e.g., revenue minus costs).
Retention Rate is the percentage of customers who stick with a company over a set time period versus go to another company.
Discount Rate is the adjustment for inflation, typically set at 10%.
Raising CLV
It follows, then, that raising a company’s CLV depends on its ability to impact those levers, namely:
- Increasing Retention and Likelihood of Repurchase
- Increasing Margins on Products Sold
- Increasing Average Transaction Value
- Increasing Customer Satisfaction
- Increasing Customer Advocacy
About What’s Next Labs: What’s Next Labs is a publication of INTO, an agency that empowers businesses to transform their aspirational goals into actual growth. Learn more about INTO at into.agency.
