How to Calculate Customer Lifetime Value
For eCommerce brands that want to grow consistently on a tight budget, it can be tough to know which customers you should focus on, whether you should try to retain existing customers or pursue new ones, and figure out which customers are most important to your brand’s success.
Fortunately, there’s a metric that can help you identify the answers to all three questions: CLV or customer lifetime value.
Not sure how to accurately customer lifetime value? Good news – this tutorial will tell you everything to know about this crucial metric and how to calculate it. Let’s get started!
Customer Lifetime Value – What is it and Why Do You Need It?
Customer lifetime value or CLV is a valuable metric that tells you the total revenue your organization can expect from a single customer or account throughout their lifetime relationship with your business.
In simpler terms, CLV tells you how much money a single customer will provide your company from the time they make their first purchase to their last purchase. To achieve this value, CLV compares a customer’s current revenue value and compares it to their predicted lifespan or time with your company.
Why Do You Need CLV? Understanding Your Data
Why calculate CLV in the first place? Simply put, customer lifetime value lets businesses just like yours identify which customer segments are most valuable to your revenue streams. After all, it's usually cheaper to keep a current customer than it is to acquire a new customer.
Suppose you can figure out which customers are more likely to stick with your company over the long term. In that case, you can focus more on retaining those customers instead of customers that will leave your organization no matter what you do.
As customers stick with your company and continue making purchases or subscribing, their lifetime value grows even further. The CLV of a customer or a customer block can significantly help your customer support, marketing, and other teams.
Furthermore, you can use CLV to determine which customers you should prioritize when cultivating brand loyalty. CLV is priceless data that you must understand if you want your business to be the best version of itself possible.
How Does CLV Affect Business Decisions?
Say that you have a company that gets most of its revenue stream from a subscription service. You identify a specific demographic of the customer base that provides you with most of your revenue using the CLV formula.
After a little analysis, your marketing team determines that the CLV of this customer group is most important to your company overall. With that in mind, you can take steps to ensure that you don’t lose those customers by:
- Marketing specifically to their desires or needs
- Offering those long-time customers special deals and sales in exchange for their continued purchases and loyalty
- And more
In contrast, imagine a company that doesn’t focus on customer lifetime value at all. They simply pursue new customers and don’t consider the lifetime value that a current customer can bring their organization.
In doing this, they end up spending more money trying to acquire new sources of revenue constantly. Over time, they lose money and go out of business.
The Benefits of CLV
When calculated and leveraged properly, customer lifetime value can provide your marketing and customer support teams with a variety of benefits, including:
- Directly affecting your business revenue. Since CLV helps you identify the customers that contribute the most revenue to your business’s bottom line, this formula also helps you get more money from your most valuable customers. By prioritizing marketing or product creation for your core customer group, you’ll inspire them to spend even more money at your organization. This positive feedback loop can keep going for as long as you continue to cultivate it.
- Improving customer loyalty and retention, especially for your most important customer base. The more loyal customers are, the lower your churn rate is, as well. This boosts your business’s bottom line and maximizes the impact of every marketing or production dollar you spend.
- Improved targeting and acquisition for your ideal customers. Once you know the CLV of your target customer group, you’ll know how much money you can spend to acquire a new customer from the same group while still making a profit.
- Reducing customer acquisition costs. As the Harvard Business Review has found before, getting a new customer can cost between 5 and 25 times more than retaining an existing one. Understanding CLV will help you keep valuable customers and save money, improving your profits in a roundabout way.
Ultimately, each of these benefits helps to describe why it’s important you know how to calculate customer lifetime value for your business analysis.
The CLV Formula
The customer lifetime value formula has you first find the average purchase value, then multiply the resulting number by the average number of purchases made by similar customers. This will provide you with the average customer lifespan. Then you simply multiply that lifespan by customer value to figure out customer lifetime value. The CLV formula looks like this:
- CLV = (Customer Value X Average Customer Lifespan)
- Customer Value = Average Purchase Value X Average Number of Purchases
So, put another way, the CLV formula could look like this:
You can calculate customer lifetime value with either version of the above formula, though the first version is a little cleaner and simpler. Alternatively, use CLV calculators online to get the math done the easy way.
CLV Formula Variables
Now you've got the basic customer lifetime value formula, but you still need to know how to find each of the variables in the formula before you can plug them right numbers in. After all, you might not know how to find the average purchase value or what that variable even means.
Let’s look at the key formula variables and metrics for customer lifetime value one by one.
Average Purchase Value
Also called APV, the average purchase value is the average revenue you make from purchasing from a single customer or customer account. You can get this by dividing the total income for your company in a timeframe by the number of purchases throughout the same timeframe.
- APV = Total Revenue / Number of Orders
Average Purchase Frequency Rate
The average purchase frequency rate tells you how often your average customers make purchases from your company. You get it by dividing the number of assets by the number of unique customers who made purchases during the same timeframe.
- APFR = Number of Purchases / Number of Customers
Customer Value
Customer value or CV tells you the value of the average customer in your organization, not a specific customer. You get it by multiplying the average purchase value for your company’s customers by the average purchase frequency rate.
- CV = Average Purchase Value X Average Purchase Frequency Rate
Average Customer Lifespan
The average customer lifespan estimates how long an average customer continues to make purchases at your company. You can get this by averaging the number of years a regular customer makes purchases from your organization.
- ACL = Sum of Customer Lifepsans / Number of Customers
Customer Lifetime Value
This predicts the lifetime value of an average customer. You get it by multiplying the average customer lifespan by customer value. Done right, it should tell you the revenue you can usually expect to get from an average customer throughout their entire lifespan.
- CLV = Customer Value X Average Customer Lifespan
Two CLV Models
In addition to all of the above variables, keep in mind that there are technically two customer lifetime value models you can work with.
Historical Customer Lifetime Value
The historical customer lifetime value model takes past data and tries to predict the value of customers without worrying about whether that customer will stick with your company or not. In this version of the CLV model, the average order value determines the value of your customers. It’s a good model to use if most of your customers only interact with your purchase from your business over a set timeframe, like a specific season of the year.
That said, the historical CLV model does have some downsides. Active customers can skew your data if they become inactive. Additionally, if inactive customers once again become active, you might overlook them by accident.
Predictive Customer Lifetime Value
The other version of the model is predictive CLV. This tries to forecast the buying behavior of new and existing customers alike. In this way, CLV can help you identify which customers are most valuable or determine which products or services bring in the most revenue.
Calculating Customer Lifetime Value – Example Case
Let’s put it all together and break down an example of the CLV formula in action. Say that you run a successful coffee shop and compete with major coffee shop giants like Starbucks. You want to know the CLV of your customers so you can improve your marketing and overall revenue.
You look at your data and find that your average customer spends about $5.90 per visit. Using the above metrics, you can calculate this by averaging:
- The money spent by an average customer during a regular visit
- During a routine week
You can calculate the average purchase value for 1, 5, 10, or even 100 customers. The more customers you calculate average purchase value for, the more accurate your CLV will be.
Once you calculate the average purchase values, add all the averages together and divide that by how many customers you surveyed. For this example, we found the average purchase value was $5.90 per visit by studying five customers.
Next, you’ll need to calculate the average purchase frequency rate. In your case, you know that most customers visit your store an average of 4.2 times per week.
You can now determine their value since you know the average customer spend rate and how many times they visited your shop. Look at each customer you surveyed to get their average value and multiply it by the average purchase frequency rate.
You repeat your calculation for all five customers and average the values to find the average customer value of $24.30.
You're almost done. Now you can calculate the average customer lifespan. This metric is a little trickier to acquire if you don't have decades of data to sift through. However, you can always divide one by your churn rate or a percentage to get a good idea of how long people continue to buy things at your shop.
Once you have average customer value and average customer lifespan, you can calculate CLV. To do this:
- Multiple average customer value by 52 (there are 52 weeks in the year)
- Then multiply the resulting number by the customer lifespan value to get your CLV
- CLV = (52 X 24.30) X 20 = $25,272
In the case of your coffee shop, the lifetime value of a customer is, in theory, over $25,000.
Summary
As you can see, CLV is a critical metric you can and should use to maximize your company’s efficiency, customer retention, and even revenue generation. With the right CLV insight, you’ll know which customers to target, how much you should spend to retain key customer groups, and much more.
While the above breakdown can help you calculate CLV in a pinch, it’s no replacement for a masterclass in eCommerce marketing and brand growth like Building Blocks.
Fortunately, you can start taking the class today with some free sample modules – check us out for more information!