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Written by: Mikkel Andreassen
There isn’t a shortage of metrics businesses must calculate to track their customers’ journey for the goal of creating a customer lifetime value. And while evaluating metrics like lead conversion rates and customer satisfaction rates should be your priority, measuring Customer Lifetime Value (CLV) — one of the few metrics that managers tend to overlook — is just as valuable. It’s the foundation for making intelligent and feasible company-wide decisions designed to boost sales and increase profits.
When you take the time to analyze the value every customer brings to your business, you better understand what can be done to scale your company. It becomes easier to figure out the exact capital you need to invest in production, marketing, and customer service, among other departments, so that you can get a high Return on Investment (ROI).
What’s understood by Customer Lifetime Value (CLV)?
When talking about Customer Lifetime Value, business executives imply the amount of money you can anticipate your customer to spend doing business with you. This metric considers the total sum the customer will spend purchasing from you before switching to your competitor and never returning or stopping contributing to your business altogether.
Since not all customers are created equal, it can be tricky to calculate the average amount most customers are predicted to spend. For this reason, it’s common for businesses to divide customers into different groups consisting of passive, active, and super active customers who bring varying profits.
Approaching CLV from several standpoints helps gauge what customers you should focus on more. It also forces you to treat your relationship with them as a long-term connection rather than a one-and-done conversion.
When you work out exactly how much money your customers bring in, you can strategize an efficient plan of action to keep them around. With the success rate of selling to a current customer, you already have reached a staggering 70% (compared to the 5-20% of selling to a new customer). You might find it more profitable to concentrate on finding ways to increase your CLV instead of spending a fortune on acquiring a few new buyers.
How do you calculate the Customer Lifetime Value (CLV)?
Before calculating Customer Lifetime Value, you need to get straight a few points. Here are the metrics you’ll have to evaluate first:
- Customer Churn Rate
- Customer Lifespan
- Customer Retention Rate
- Average Profit Margins per customer
Once you have the above numbers ready, you can start computing CLV. You can use two formulas: Predictive Customer Lifetime Value and Historical Customer Lifetime Value.
Predictive Customer Lifetime Value mimics your customers’ transactional behaviors to forecast their future actions. It uses algorithms that help generate an accurate CLV while predicting the total value one customer brings to your business.
You have to account for all the past transactions that have occurred concerning this customer when calculating this metric: CLV=LT(Customer Lifespan in months)*T(Average Number of Transactions per month)*AOV (Average Order Value)*AGM(Average Gross Margin).
Historical Customer Lifetime Value differs in that it’s used to calculate the sum of gross profit from one customer’s past transactions. It’s best suited for companies whose customers have the same preferences and transactional behavior patterns. If you want to merge both old and new customers, this is the metric to use.
To calculate it, combine all customer transactions and divide them by the Average Gross Margin (AGM). The final number you’ll get will help you understand how profitable your customers are to your business.
What are the advantages of calculating Customer Lifetime Value (CLV)?
The metric is at the heart of every financially stable business that wants to get the most bang for its buck. To ensure that your company stays profitable, continues to retain old customers and attracts new ones, you should make measuring Customer Lifetime Value a standard practice.
- It helps you have a steady cash flow. When customers come back to you, there’s no volatility of the cash inflow. It becomes easy to keep your payments in check and be confident about when and from where the money is coming.
- It allows you to evaluate the performance of your marketing campaigns. Although there are specific marketing metrics to assess your marketing campaigns’ success — think Cost-Per-Click, conversion rates, and return on marketing investment — knowing your CLV number provides you with even more insights.
- It enables you to bring in more target customers. It’s easier to plan your customer acquisition budget when you know exactly how much money a customer is spending. This way, you’re able to spend more when planning to reach a specific group of customers and focus on attracting the right buyers only.
- It gives you a good understanding of how much your company is worth. If your customers tend to spend $100 when buying from you, it’s not difficult to calculate your company’s overall worth. It’ll also serve as a valuable piece of information when negotiating with investors and banks when looking to expand your business.
- It offers you room for growth. No matter what industry you’re in, scaling a business is a part of everyone’s agenda. It’s impossible to grow if you’re not reinvesting in your company, and for that, you need to ensure that your business is doing well financially. Calculating CLV can help guarantee financial security coming from recurring revenue.
How can you improve your Customer Lifetime Value (CLV) metric?
1. Prioritize customer retention
Did you know that an average American company loses 23-30% of its customers every year because of a lack of customer loyalty? Combined with the difficulty of bringing customers back, this can backfire in more ways than one.
To avoid having to spend a fortune on sophisticated marketing campaigns that would attract new customers, consider taking control of your churn rate. It’s usually affected straight after the customer’s first engagement with your company when he forms an impression about your brand. Here’s where asking for feedback and incentivizing the customer with a discount for his next purchase comes in handy.
It also pays to nurture the existing customers by segmenting your audience and personalizing newsletters and other emails. Engaging with them on social media platforms on which they’re the most active is another way to catch and hold their attention for a prolonged period.
2. Personalize communication with customers
It’s becoming increasingly critical to mention the customer’s name and cater to his needs, and personalization is always best to keep in mind. Whether it’s a private message on Instagram or a piece of content posted on the website, your customers are to feel that it’s for them.
As many as 80% of customers are more likely to buy from a company that provides personalized experiences. This number alone should prompt you to reevaluate your communication style and make an effort to appeal to customers with carefully crafted and customized messages.
Apart from sending individual emails with promotions, you can also develop a personalized homepage highlighting products your customers would deem relevant. If you want to take it a step further, show related products when the customer views a specific item or adds it to his cart.
3. Use first-party data
To have a good understanding of your customers’ needs and wants and provide personalized experiences, you need to leverage customer data. Since CLV is data-based, it’s vital to be using high-quality data that offers valuable insights. The first-party data is the most accurate information you can get to improve the content you are personalizing.
First-party data includes the number of product views, form submissions, customer interactions with your brand, and even in-site search queries. When gathering it, you should learn more about what your typical customer looks like and how to reach out to those who look just like him. It’s also helpful for retargeting via marketing campaigns and nurturing old customers.
4. Find ways to increase the average order value
Perhaps the most straightforward method of increasing your CLV is to push for more significant average order values. You can achieve this by creating bundles and offering them to your customers as a deal with the best value. Offering a complimentary product when the customer is about to make the purchase is also a great way to increase the total sum of his order.
When finding the right combination of products to recommend, you should consider the customer’s preferences. If it’s a pair of headphones, a case will go well with it. The same applies to offering freebies — they should be aligned with what a customer would purchase regardless of the price tag.
5. Optimize your onboarding process
There can’t be happy customers who will contribute to a CLV that’s three times higher than your Customer Acquisition Cost (CAC) if your customer support team isn’t working to its full potential. To help your team achieve that, you should invest both time and financial resources in training your employees to provide the best possible onboarding process.
It’s best to start it as soon as possible and take the time to personalize it. You can give your customers a quick walkthrough and help them help themselves by filming a video tutorial or creating step-by-step manuals.
CLV is the metric that can either make or break your business. Since it goes hand in hand with brand loyalty and customer satisfaction, you should prioritize delivering exemplary customer service that stimulates positive reviews and returning customers. Personalize your communication with customers and optimize your customer support, and you’ll see a stable cash flow and exponential growth of the company.
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Mikkel Andreassen is passionate about customer experience in every color of the beautiful customer engagement spectrum. He loves building great connections with his customers, which often lead to meaningful friendships that last a lifetime and inspire his work. Driven by the genuine belief that CX is the pivotal force that drives a successful business, he is currently at the helm of Dixa’s customer experience strategy.