Ever wonder why some businesses thrive while others struggle? Just like those who thrive, struggling businesses also invest time, money, and energy. So, why do they still see a big revenue gap between customer acquisition numbers and customer purchase records?
This is a shared struggle among many businesses—to successfully convert acquired customers into repeat purchasers. Because statistics say there’s a higher probability (up to 70%) of selling to an existing customer than to a new one.
Do you know the secret formula of thriving? One is by mastering the customer lifetime value metric. So buckle up. Let’s understand this very important metric measure customer lifetime, learn how to calculate it, and unravel the mystery behind its significance in your business success.
The basics of customer lifetime value (CLV)
By definition, customer lifetime value (CLV or LTV) is the projected revenue a typical customer will generate over their lifetime or simply before they churn.
Understanding CLV involves looking at past customer behavior to estimate their future value—but start-ups (without past customer data yet) can still calculate it. So, technically, there are two types of CLV:
- Historical CLV that calculates based on the historical interactions of a customer with your business.
- And one that uses benchmarks and analytics to forecast the lifetime value of a customer, called Predictive CLV.
But here’s an arguable point—while many businesses focus on a customer’s first purchase, the real value is in nurturing the relationship formed so it becomes long-term and those customers buy over and over again.
But what else do you get from understanding customer value beyond the initial purchase?
- Total customer value shapes product development tailored toward repeat usage. SaaS businesses, for example, can drill down on a particular feature they should focus on enhancing since customers find it most valuable or useful.
- Knowing high-value customers versus one-time purchasers lets you refine marketing campaigns and integrate cross-selling and up-selling opportunities.
- Apparently, one-time sales may be unprofitable after acquisition costs. But if you know your customer’s lifetime value, you can judge if your upfront investment is worthwhile.
The CLV formula unveiled
Here’s the deal—there is no one correct way to calculate customer lifetime value.
The most basic calculation for CLV includes these metrics: the average purchase value, the purchase frequency, and the average customer lifespan
FORMULA: LTV = (Average Purchase Value) x (Purchase Frequency) x (Customer Lifespan)
Simply multiplying the three gives you the standard customer lifetime calculation. So, let’s say you’re selling beauty creams for $10. The average customer uses your product for at least 2 years before switching to another brand. During their stay, they buy twice per year on average. That gives your CLV to be 10*2*2= $40.
But since we said that this is especially useful for subscription businesses, we tweak and give you a more detailed customer lifetime formula. This includes the gross profit and expected churn. So we refine the CLV equation as follows:
EQUATION FOR CUSTOMER LIFETIME VALUE = (Average Revenue Per Customer x Gross Margin % x Average Customer Lifespan)
- Average revenue per customer (ARPU) is the average amount of revenue generated by a customer in a given period. This involves your MRR, your monthly revenue.
- Gross Margin % represents the percentage of revenue that exceeds the cost of goods sold (COGS) —this assesses the true profitability of each customer.
- Average customer lifespan, similar to the traditional CLV formula, represents the expected duration of a customer’s relationship with the business. We can also compute this by first identifying the customer churn rate. The churn rate represents the percentage of customers who discontinue their subscription within a specified period.
Here’s an illustrative example:
Say a company XYZ’s subscription service costs $50 per month. Their customers tend to stay engaged for an average of 12 months renewing monthly before unsubscribing. The gross margin of the company stands at 60% since 40% is allocated for development, marketing and sales. A customer’s lifetime value is calculated by:
CLV = (50×0.60×12) = $360.
This means the anticipated lifetime value by XYZ for each of their subscribers is $360. Consequently, this also means that the company can spend up to $359 in acquiring their customers and still be profitable.
How to calculate CLV for your business
So, what is the lifetime value of customers in your company? Here’s how to calculate CLV of most valuable customers in three easy steps:
Step 1: Gather data
Assuming you’re not a start-up, you can start by collecting the necessary data that will fill your customer lifetime value formula. If you’re a subscription-based business model, make sure you include the percentage of gross margin.
Step 2: Plug in your values
This is very straightforward. Substitute the gathered data into the customer lifetime value formula.
Step 3: Do the math—complete the calculation
Finally, execute the calculations to find the CLV. Ideally, this should not be bigger than your customer acquisition cost (CAC).
Tools and additional resources to further simplify the CLV calculation
If you want to further simplify how you get your customer lifetime calculation (because you just don’t get the data for the three steps out of the blue), here are some tools we suggest:
1. Customer relationship management (CRM) system
A CRM centralizes customer data into a single system. This ensures accuracy in CLV calculations by providing a comprehensive and up-to-date view of customer interactions, including transaction records. Some popular CRMs are Salesforce, HubSpot, and Zoho CRM.
2. Analytics platforms
Talking about advanced analytics that incorporate machine learning models, these platforms can analyze historical data to predict future customer behaviors that can affect the accuracy of customer lifetime calculation.
3. CLV calculators
Manual CLV calculations are time-consuming and often inaccurate. Conversely, there are now online calculators designed specifically for CLV which can streamline the process drastically. They standardize the CLV computation so everyone’s calculations are the same.
4. Business intelligence tools:
Did you know that a business that uses business intelligence makes faster decisions five times more than one that doesn’t?
Detecting changes in customer behavior in real-time is crucial for proactive CLV management. Thankfully, BI tools support ad hoc reporting. You can generate flexible, customized reports tailored to specific CLV requirements whenever needed. Not to mention, BI tools often feature intuitive dashboards that present CLV metrics in a visually appealing and comprehensible manner.
5. Customer survey tools
Customer survey tools allow businesses to create and distribute satisfaction surveys. By using customer feedback and gauging customer satisfaction levels, businesses can factor this qualitative data into CLV calculations. Satisfied customers tend to stay loyal and enhance their lifetime value.
Why the Customer Lifetime Value formula matters
Here’s where we get even more real—the lifetime value formula is not just a mathematical concept. If leveraged, it’s your compass to sustained growth and profitability.
CLV formula guides your planning.
Whether it’s refining marketing campaigns, optimizing product offerings, or enhancing customer service, strategic planning guided by CLV insights ensures that marketing efforts align with the value each customer contributes and is predicted to contribute.
CLV formula helps allocate resources for retaining first time buyers.
CLV insights make sure you optimize how you spend your budget and resources. It guides you in tailoring retention strategies specifically for first-time buyers. By understanding the factors that contribute to long-term value, such as repeat purchases and brand loyalty, businesses can craft retention campaigns that are in tune with a particular segment’s preferences and behaviors.
CLV formula serves as the North Star in decision-making.
Since CLV is a forward-looking metric and is about the total value a customer is expected to bring over, understanding it becomes the North Star in every strategic decision-making. This one metric can motivate businesses to focus on the long-term impact of their strategies and investments rather than solely on short-term gains.
CLV formula can direct you to optimal enhancing of customer experience.
Understanding the lifetime value of customers empowers you to tailor experiences that will truly resonate with your audience. From personalized communication to anticipating needs, businesses armed with CLV knowledge deliver experiences that leave a lasting mark and trigger loyalty and repeat engagements.
CLV formula helps evaluate the efficiency of customer acquisition costs.
CAC should not be greater than CLV. It’s estimated that the customer lifetime value should be three times greater than the acquisition cost. So by comparing CLV to CAC, businesses can assess the return on investment (ROI) for acquiring new and existing customers together. Based on this data, CLV informs choices on optimizing marketing channels and tactics to ensure sustainable profitability.
Debunking CLV myths and misconceptions
Despite the significance of CLV equations, misconceptions about them may cloud their true essence. So, let’s have some myth-busting fun and clear up the misconceptions for a clearer understanding of CLV’s role.
Myth #1: CLV is an exclusive tool for large enterprises.
Wrong. CLV is beneficial to every business. Small and medium-sized companies can also leverage CLV insights to enhance customer relationships, optimize resources, and ensure sustainable growth.
Myth #2: CLV is only useful for customer retention.
Yes, CLV is very much relevant to customer retention. But while it’s vital for retention efforts, its insights also inform the direction acquisition strategies and customer segments must go. This empowers businesses to attract and nurture high-value customers in a cost-effective manner.
Myth #3: Calculating CLV is too complex.
Yes, the formula involves multiple variables, but you can use tools and calculators to simplify the process. Additionally, a basic understanding suffices for businesses to start deriving value from CLV insights. We just talked about calculating it in three easy steps above.
Myth #4: CLV is just a theoretical metric.
This is so wrong! CLV is highly actionable. It guides decisions on marketing strategies, allocating resources, and engaging customers. This translates into tangible improvements in business performance.
Myth #5: CLV is only for subscription-based businesses.
No, CLV is adapted by various business models. It’s equally applicable to e-commerce, services, and other industries where customer relationships ideally extend beyond a single transaction.
Myth #6: CLV is solely a predictive tool.
While CLV aids in predicting future by measuring customer lifetime and value, it also provides real-time insights. So, monitoring CLV regularly is what enables businesses to adapt strategies promptly.
5 practical tips for implementing CLV strategies
Want now to elevate your CLV game? Here are five practical tips that can transform CLV theories into actionable strategies.
Streamline user onboarding
To maximize and improve Customer Lifetime Value (CLV), streamline user onboarding. Bad customer onboarding is enough for 40-60% of software users to lose interest after their initial sign-up. Try personalizing welcomes or simplifying the onboarding steps with interactive tutorials. Also, encouraging feedback, and incentivizing completion add to creating a positive and engaging experience.
Provide outstanding customer support
Delivering top-notch customer support directly impacts Customer Lifetime Value (CLV). A solid tip? Make your support an icon of reliability and satisfaction. Respond promptly, resolve issues effectively, and just go the extra mile. Yankee Publishing generated over $3 Million in sales by having a dedicated customer success team.
Here’s another tip for implementing customer lifetime value strategies: Segment your customers! In fact, it increases sales returns by 3 to 5%. So, instead of a one-size-fits-all approach, divide your customer base into distinct groups. By understanding the unique needs of each customer segment, you can tailor strategies that resonate, boosting customer loyalty and maximizing their lifetime value. It’s like having a personalized strategy for every kind of friend at your CLV party.
Always integrate CLV into decision-making
Picture CLV as your strategic co-pilot; it should be in on every decision-making rendezvous. Whether you’re tweaking marketing campaigns, refining user experiences, or product development, let CLV be the guiding star. When it becomes a natural part of your decision-making process, you’re not just implementing CLV strategies—you’re living them.
Align CLV with every customer journey
Craft the initial customer experience with CLV in mind. Ensure that first interactions set the foundation for a fruitful, long-term relationship. Also, use CLV to guide ongoing customer nurturing efforts. From post-purchase communications to loyalty programs, every touchpoint should contribute to CLV growth.
Master calculating lifetime value and enjoy a boost in revenue
Knowing and mastering the customer lifetime formula is a much-needed business strategy if you want to keep thriving. Beyond calculations, CLV empowers businesses to think beyond transactions, allowing them to build enduring customer loyalty, boost profitability, and grow strategically. Furthermore, calculating customer value over time is crucial in tackling customer churn.
But note that involuntary churn exists—so whether you like it or not, you’ll have churn. To minimize this unwanted metric, set up a system to recover failed payments. RecoverPayments, with our dedicated retention specialists, will strategize and execute payment recovery campaigns for you. Reach out so you can get back your “almost lost” revenue and improve customer retention.