How to calculate customer lifetime value and other key business metrics?
In this blog post, we will look at how to calculate, utilize and improve one of the most important metrics for any growing company, your customer lifetime value (CLV).
7 min read
Business metrics are valuable tools that help us to run successful businesses; they do this by analyzing and measuring growth. Key business metrics (KPIs) allow us to track and analyze data to show the progress of a company’s goals within a specific timeframe.
Customer lifetime value (CLV) is one of the most important metrics for any growing company. Studies have shown that the real growth hack is investing in customer retention and growing their lifetime value, as this can help boost profits faster than acquiring new customers. Not only does CLV help you build long-lasting customer relationships, but it can help you measure how long it takes to recoup your investment, allowing you to both boost profits and save on your sales and marketing spend.
Customers are at the center of any business; understanding your customer lifetime value and knowing how to accurately calculate it will help you identify where best to invest your time, money, and resources when acquiring and retaining valuable customers.
What is Customer Lifetime Value
Customer lifetime value is a metric that is used to indicate the customer value to a business over the course of your relationship. Comparing CLV to Customer Acquisition Cost (CAC) enables companies to identify the long-term valuable customer relationships, predicting how much revenue you can expect one customer to generate throughout the course of the relationship.
CLV is an important metric as it shifts the mindset from transactional to long-term nurturing; this is valuable as it costs less to keep existing customers than it does to acquire new ones. Therefore, the longer the customer continues to purchase from the company, the larger the customer lifetime value becomes and the larger the overall company growth.
Along with increasing revenue, CLV also helps you budget by estimating how much marketing and sales spend you should invest in order to retain a customer. By understanding what you need to be doing to keep a customer, CLV can also play a key role in developing strategies to acquire new ones.
How To Calculate the Customer Lifetime Value Of A Company
While there are a number of programs and SaaS companies out there to help you calculate and measure metrics like CLV, knowing how to calculate your customer lifetime value manually will help you understand the financial health of your business better.
The simplest way to determine CLV is to calculate the average revenue and to multiply it by the average customer lifespan. However, accurate calculation of a CLV requires first calculating a number of different metrics:
Average Purchase Value
The Average Purchase Value measures the average sales value of the transactions. APV is calculated by dividing the total sales of the company by the total purchases made by the customers. In some cases, APV can also be calculated with the total gross margin (GM), which is the total sales value, minus the costs of the goods sold (COGS) and customer acquisition cost (CAC).
APV = Total Sales/Number Of Orders
On an average week at Johns Pizza Shop, he has 50 orders, with the total for the week coming to $1,000; this means that the APV is $20.
If we were to calculate APV with the total GM, we would have first deducted the $250 for the COS and CAC, making the total revenue $750 and the APV $15.
Average Purchase Frequency Rate
The Average Purchase Frequency Rate is calculated by looking at the total purchases made over a period of time by an individual customer who made those purchases.
APVR = Number of Orders / Number of Customers
Of the 50 orders at Johns Pizza shop, 35 of them were unique customers making the APVR 1.4
Customer value is calculated by multiplying the average purchase value by the number of times a purchase is made.
The APV is $20, and this is divided by the AVPR of 1.4, meaning the CV is $14
Average Customer Lifespan
Average Customer Lifespan refers to the average number of years that an individual continues to be a customer.
ACL = Sum of Customer Lifespans/ Number Of Customers
Johns shop is a bit of an institution, with the 35 customers coming from a total of 700 years, making the ACL 20 years.
Customer Lifetime Value Formula
Now that you understand what metrics you need to calculate CLV, we can look at the formula. CLV is able to measure how valuable a customer is to the company by comparing the customer’s revenue to the customer’s predicted lifespan.
Average Purchase Value X Customer Lifespan = CLV
The average revenue on a takeaway pizza is $15, and on average, a customer orders a pizza twice a month over an annual period, with the average lifespan of a customer being ten years.
The lifetime value is calculated at:
CLV = $15 X 2 X12 X10
This CLV formula is often referred to as a historical CLV as it looks at the historical data and bases its calculations on averages. However, the lifetime value figure can also help businesses estimate the future cash flow and estimate the number of customers needed to obtain to achieve profitability.
How To Improve Customer Lifetime Value
A low CLV means that you are losing customers, and while it might not impact your weekly turnover, a lack of customer loyalty can severely affect yearly reporting. There are a number of factors that contribute to your CLV; it can depend on product, costs, branding, marketing, and most of all, customer experience. Customer experience is vital in keeping your churn rate down as if your customers are satisfied with your service; they are less likely to look for a new rival company.
Now we know how to calculate the lifetime value of a customer, we can look at ways to improve it. Improving your customer lifetime value is all about nurturing it; nurturing will result in customer satisfaction and retention, increasing your overall growth.
Identify Your Most Valuable Customer Type
By calculating your CLV, you will be able to identify your most profitable customer type. This information will help you better understand your most valuable clients and, therefore, know how to target them to increase your revenue. Customer lifetime value is all about loyalty, so why not encourage loyalty by rewarding it. For those who are your most loyal, you can nurture them and encourage them to keep coming back by offering free shipping, benefits, discounts, or early access.
Another way to improve loyalty is by investing in a customer relationship manager (CRM). A CRM can help you personalize and tailor your sales and marketing strategies to best attract your most valuable customers. Through content personalization, you are able to activate audiences and refine your retargeting, cross-sale, and upsell initiatives. Carefully personalized user experience will significantly boost revenue and CLV.
Invest In Customer Experience and Satisfaction
Customer experience is one of the most vital aspects of a business when it comes to acquiring a customer; it is just important when trying to keep them. Good customer experience refers to everything from branding, shop usability, customer service, product use, and their experience with your brand via social media platforms, and providing a premium service will keep your customers satisfied.
A key aspect of customer satisfaction is listening to your customers and finding out their needs and wants, and adapting to your strategy to ensure their repeat business. Besides asking for reviews, why not go one step further and ask for customer feedback or conduct market research to find out what your customers want. Getting honest feedback will allow you to address your customer pain points, enabling you to tailor your business to suit your most valuable demographic, resulting in better client satisfaction and lower churn rates.
Customer lifetime value is not the only metric you will need for your customer to grow; however, it is an incredibly valuable tool to help you better understand and nurture your customer. Along with showing you how to nurture your customers, CLV provides invaluable feedback on your sales and marketing strategies and your overall brand. If you notice that your CLV is low, you can refine your business strategy to reallocate your time, money, and resources to target your most valuable customers better. In a competitive marketplace where customers can easily swap between brands, paying close attention to this metric will help you gain a competitive advantage and grow.