Customer Lifetime Value: how much is your customer worth to you and why do you need to know?
2 February 2022
If you want to grow your business or optimise your operating costs, you have to be aware of your Customer Lifetime Value (CLV). By comparing your CLV with the costs that you incur when attracting new customers, (the so-called Customer Acquisition Cost or CAC), as a business you can calculate the real return on your marketing investments. How do you calculate Customer Lifetime Value?
What is Customer Lifetime Value?
Customer Lifetime Value is the calculated average value of a customer over the assumed period that they will remain your customer. The model therefore takes into account the turnover value of a customer and links this value to the (predicted) lifespan of the customer relationship. Having a lot of customers is nice but having a lot of valuable customers who also remain loyal to your organization in the long term is better.
How do you calculate the Customer Lifetime Value?
To calculate your Customer Lifetime Value, you need to identify a few other parameters. We will explain this step by step for a fictitious customer called Peeters.
1. Calculate the customer’s average purchase value: Divide the revenue that your company generates from the customer over a certain period (for example, 1 year) by the number of purchases made by that customer in the same period. If customer Peeters spends € 300 per year in 3 purchase moments, the average purchase value is therefore € 100.
2. Identify your customer’s purchase frequency: how often does the customer buy from you in the relevant period? For the customer Peeters this is 3 times.
3. How do you calculate the average customer value: you do this by multiplying the average purchase value by the purchase frequency. For customer Peeters this is 3 x €100 = €300.
4. Estimate the longevity of your customer relationship. How long will your customer remain an active customer? That isn’t always easy to estimate. Let’s assume that for your customer Peeters, this will be 6 years.
5. Calculate your customer's CLV: Multiply the customer value by the estimated lifetime of your customer relationship. Now you have an indication of how much revenue your customer will generate over the entire duration of the customer relationship. For your customer Peeters this amounts to € 300 x 6 years = € 1,800.
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No one-size-fits-all model
Unfortunately, there is no one-size-fits-all model for calculating customer lifetime value. For companies that generate their turnover on a contract or subscription basis (telecom, insurance, etc.), the calculation is usually easier than for retailers. At iO, we usually advise our clients to start on a small scale and then to refine their CLV model in stages. It’s important to check what current, reliable data is available in your company and think about how you can expand this dataset in the future.
Why do you need to know the Customer Lifetime Value of your customers?
Because knowledge is everything. We’ve already talked about the Customer Acquisition Cost (CAC) or the cost of bringing a new customer to your business. Often the focus of this cost is on advertising campaigns, but the production of organic content can also be labour and cost intensive. If you establish and then compare the CLV and the CAC, you will see clearly how effective your marketing efforts are. If the CLV of your customer Peeters is € 1,800, but the CAC is € 2,000, you are making a loss and it’s worth thinking about your campaign structure.
Mapping the CLV is therefore essential to adjust and target your marketing budgets. Certain channels or campaigns may have a low Cost Per Action (CPA), but if the customers you bring in with them are only with you for a few months, the long-term return can be quite disappointing. Conversely, a high CPA can still be profitable if you attract customers who spend more than the CPA during your relationship.
How do you increase Customer Lifetime Value?
It goes without saying that you strive for the highest possible CLV, but what can you do to increase customer lifetime value? Customer satisfaction and retention are essential here. After all, satisfied customers stay loyal and deliver a higher yield. Attracting new customers is a lot more expensive than retaining existing customers. Offering good after-sales service, for example, can boost both customer satisfaction and retention. Focused marketing can also help. By approaching customers strategically after their first purchase, they can be encouraged to make new purchases. Loyalty cards that offer your customers special, defined discounts can also be useful.
Steven van DuyseStrategy Director
Being someone who prefers the hunt over the catch, Steven is the person to talk to for result-driven solutions to operational challenges. At iO, he merges strategy with sales - leaving every organisation with a team tailored to their needs.
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