This post has been updated and was originally published in July 2020.
If you’re not calculating the lifetime value of your customers, here’s why you might want to start.
Here, you’ll find:
- What “customer lifetime value” means
- Why it’s important to calculate
- How to determine the lifetime value of your customers
- What next steps to take
Many companies are getting it wrong when it comes to calculating how much they stand to gain from a customer.
That prize: The lifetime value of that customer.
With any luck, a customer isn’t just worth a single subscription, closed deal, or purchase from your store. The customer journey doesn’t end when they sign on the dotted line.
Rather, it’s better to look at what that customer is worth by the value they can bring through a lifetime interaction with your brand. This could be through additional purchases, annual renewals, or referring others to you.
If you’ve been struggling to reach your overall marketing goals, make sure you’re calculating lifetime value as one of your KPIs. These figures help you determine how much an average customer is worth. They can also help inform how much you should budget in order to retain them.
Customer lifetime value: defined
As we mentioned, a customer’s lifetime value is the value that a customer has for your business over the lifetime of their interaction with your brand. To calculate it, there are a few factors to consider.
How much is the average purchase from a customer? That is, how much does the average customer spend with your brand? Keep in mind that many customers will spend more with your brand if their initial experience is positive. Once they can develop trust in you and the solutions you have to offer, they may be willing to make more big purchases.
How often do customers make purchases? How often does the average customer come back to your business for future needs? In the case of some brands, that may mean monthly purchases, annual contract renewals, or add-on services.
Others may find that a customer visits more or less frequently. The average customer at their favorite restaurant, for example, might come by or place a takeout order once a week. The average customer at a car dealership may only visit once every several years.
How long do customers stay with your business, and what’s their average lifetime with your business? Customers may naturally move through your business over time: new ones come on, old ones leave. By understanding how long they’re likely to stick with you, you can get a better idea of a customer’s lifetime value.
Why is a customer’s lifetime value important?
A customer’s lifetime value is important to your business for a number of reasons.
First, data shows it costs you less to keep a current customer than it does to acquire a new one. You may also find that appealing to existing customers through your advertising is less expensive than attracting brand-new ones.
Increasing retention by only 5% can lead to as much as 95% more profits. Moreover, even retaining 2% more customers can save you 10% on costs.
Your customers’ lifetime value can help compensate for your customer acquisition cost (CAC). If you’ve noticed your CAC creeping up, looking at a customer’s lifetime value can give you a better idea about what your customers are worth to your business. This, in turn, can potentially increase your willingness to raise your ad spend.
Reasons your CLV might be low
If you aren’t keeping your customers around, you need to consider why.
Some businesses are accustomed to fleeting traffic. It’s normal for most businesses to have one-time customers who come in to fill an immediate need but may not need to use their business again in the future.
Most businesses, however, should consider the importance of maintaining a relationship with existing customers. This makes it easier to bring them back for future purchases.
If you aren’t bringing in repeat business, ask yourself: why not? It could be a matter of prices that are too high or a lack of quality customer service. Maybe you’re not nurturing clients once the deal is closed, encouraging them to refer others or purchase additional items or services.
It could simply be that your business isn’t leveraging marketing to stay top of mind for your customers. This decreases the likelihood that customers will return.
How to calculate CLV
There’s no single equation that is universally agreed upon when it comes to calculating a customer’s lifetime value — if only it were so simple!
As The Startup explains, two common ways you can calculate CLV are historically and predictively.
The historical method is based on purchases your customers have made in the past. You find this figure by determining a time period. Then you divide your total revenue by the number of customers during that time. This gives you the average revenue per user.
From there, you can multiply or divide it to determine this figure on a monthly or annual basis.
The predictive approach is a bit more precise. This method involves looking at a customer’s transactional behavior to predict what actions they may take in the future.
This formula multiplies average order value, average gross margin, average number of monthly transactions, and average customer’s lifespan in months together. From there, divide that result by the number of clients for that time period.
Here’s a more basic formula:
(Average purchase value) x (number of times the customer makes a purchase each year) x (average amount of years the customer relationship lasts) = CLV
There are other more advanced formulas as well, if you want more options.
Tips to increase CLV
As you develop a better understanding of customer lifetime value and its importance, the next step is determining how you can increase it. Increasing customer lifetime value can boost your business’s revenue without substantially increasing your marketing efforts or ad spend.
When customers visit your website, they should not only receive information about the product or service they’re looking for, but about the accessories and additions that go along with it, if applicable.
For example, a customer buying a grill may need a cover, utensils, or propane. Someone who purchased the basic-level tier of your service may be interested in the deluxe or enterprise version as their needs grow. Consider offering recommended pairings to go with a purchase. These potential upsells could pop up on the product page, as recommendations in the shopping cart, or via email.
Consider targeting ads to customers who have already visited your website, or even those who have made a purchase in the past. You can create retargeting (also called remarketing) ads designed to target the types of products customers have already considered buying or offerings that go along with a past purchase.
Retargeting can keep your business top of mind for those customers, bringing them back to you when they have another need for products or services in your industry.
Improving your customer service
Your overall customer service is one of the biggest indicators of whether someone will return to your brand. People want to feel valued and heard. Whether they’re coming to you with a problem or offering quotes of praise, responding in a personalized, respectful way can take you far.
It’s not the presence of a problem that will lose a customer. Rather, it’s how you choose to deal with the situation. That comes through via the quality of the service that you offer to your customers.
Plus, you can repurpose client testimonials for marketing on your website and social media. This makes your clients feel heard and appreciated while helping to boost your credibility.
By empowering your customer service team, you can increase the likelihood a customer will stay with your business, which can ultimately increase lifetime value.
Pro tip: Google Analytics has a CLV report (dubbed LTV for lifetime value) that will break down data about your users’ behaviors, from the first interactions to page views, goals, and more.
As you can see, a customer’s lifetime value is of critical importance to your business.
By tracking the average lifetime value of your customers, you can move towards increasing your understanding of how to reach your customers.
In turn, this can help you better target your ads and understand what your customers need to stick with you over your competitors.