What is Customer Lifetime Value, and Why is it Important?

Do you know how much each customer is worth to you? How do you improve new customer acquisition, increase repeat purchases, or increase profitability?

Customer Lifetime Value can certainly help you answer these for you and so much more. I want to say Customer Lifetime Value may well be one of the most important numbers you should be tracking in your business in order to operate and grow in a healthy sustainable way.

In this article, I’ll explain what Customer Lifetime Value is, why it’s important, what that value means to your business, and how you can maximize Customer Lifetime Value to grow your business.

What is Customer Lifetime Value or CLV?

Customer Lifetime Value, or CLV, is a net present value of the net profit from a customer over the lifetime of their relationship with the brand. This is predicting the net profit of a customer with the brand in today’s dollar value.

Customer Lifetime Value, or CLV, is a net present value of the net profit from a customer over the lifetime of their relationship with the brand. This is predicting the net profit of a customer with the brand in today’s dollar value.

Although the name says it’s a “lifetime” value and some experts tell you to calculate the total net profit of a customer over their entire lifetime with your brand, this may not be practical to do so.

For example, in the widely-known Customer Lifetime Value case study of Starbucks, they calculated that their average CLV is $14,099. This is based on their 20-year average customer lifespan.

How much in your business do you think changes in 10 to 20 years that might affect Customer Lifetime Value? I’m sure competition, market trends, and all sorts of other factors can change this value during that time which makes this figure of $14,099 quite meaningless if you take that at face value. 

To solve this issue, keeping your calculations tight to about 3 years may be more relevant and realistic.

Let’s look into how Customer Lifetime Value can be used in a business setting and why it’s important to you.

Why is Customer Lifetime Value important?

Customer Lifetime Value is becoming important in marketing as more marketers try to target more profitable audience, measure their marketing campaigns, and increase their marketing ROI.

The concept of CLV should also matter to senior-level executives and board members because it can help them build a financially strong and sustainable business model by focusing on long-term profitable objectives rather than short-term immediate revenue boost.

A great example is a new marketing initiative, such as a loyalty program or opening up a new channel, that requires a big investment up front. You frequently hear businesses say “we’ll make it up” or even talk about Return-on-Investment (ROI) but such campaigns have a bigger impact than simply acquiring new customers.

In such example, rather than focusing on how much new business that initiative or campaign can bring in right away, it’s important to evaluate the overall impact to the business. It may not only bring new customers but also increase how much existing customers buy from you and how much longer they may stay with you.

Many businesses already take the initiative to maximize their Customer Lifetime Value but they just don’t relate that to CLV. Every business work hard to sell more and stay more profitable but they just don’t know how. Customer Lifetime Value is important because it helps you do just that.

Knowing the value of your customers will tell you a lot about whether your company strategy is right for the type of customers you’re targeting. It will also tell you whether your cost to acquire and retain them is aligned with your current profit margin.

Also, CLV is important because it can tell you a lot about your current customers and business. Don’t they always say “know your customer”? Well, this is the perfect way to learn and analyze your customers.

So, what questions can it answer for your business?

The process of calculating the Customer Lifetime Value will tell you:

  • Retention rate: how long and how much of your customers you’re keeping
  • Churn rate: how much of your customers you’re losing
  • Average Order Value: how much customers are spending per order or visit
  • Frequency rate: how often customers are buying
  • Average lifetime: how long an average customer will do business with your brand
  • Acquisition cost: how much you’re spending to acquire each new customer
  • Marketing cost: how much you’re spending to advertise, retain, and grow your customers
  • Product cost: how much your products or services cost
  • Discount rate: the rate of adjustment to convert your future customer lifetime value to the net present value so you know what it’s worth to you now
  • Referral value: how much customer referrals are worth

Once you have calculated your CLV, it can guide you with:

  • How much you could be spending on acquiring new customers to stay profitable and estimate its financial impact
  • What type of new customers you should be acquiring
  • how much you should be spending on retaining customers
  • Which customers you should spend money on to retain
  • If your new marketing campaign might be worth investing in and its estimated financial impact
  • And more

This process itself can help you go through different areas of your business so you can make improvements to increase your revenue and profit.

How to segment your customers

Measuring the Customer Lifetime Value on your entire customer base won’t mean much. This value is best measured when you take a specific cohort or group of customers.

This is a very important step to segment your customers in meaningful groups, or cohorts, to analyze. If you combine all your $10 customers with $1,000 customers, your results are skewed that satisfy neither group.

Once you segment your customers, no new customer will be added to the group since you’re measuring the effects of that specific group.

You may segment by:

  • Acquisition channel
  • Product line
  • Purchase behavior
  • Demographics
  • Profit margin
  • And more

Each segment’s CLV will tell you something you can use to evaluate different things.

For example, segmenting by acquisition channel, such as PPC, social media, or email, may show you which channel customers are more profitable because they spend more or stay longer with you. That can help you plan reallocating your budget to channels that are more profitable.

Segmenting by purchase behavior, such as buying frequency or average order value, may tell you that you should be spending more money on retaining a certain group of customers.

The key here is to do it “in a meaningful way”. If you’re segmenting customers with the first name John, it won’t provide much meaningful actionable insight.

How to maximize your Customer Lifetime Value

Although it may take some time and resources to do it, it pays to know and maximize your Customer Lifetime Value.

So what can you do to maximize CLV? The worst strategy is to try to do better in everything!

Why? Because you won’t have a focus to dedicate your resources to all projects and it’s difficult to measure “better”.

There are quite a few ways to increase and maximize your Customer Lifetime Value depending on the nature of the business and industry.

Here are a few examples of how you can maximize your CLV:

  • Increase your retention rate by X% by implementing a loyalty program
  • Decrease your marketing cost by increasing your return-on-ad-spend (ROAS) by X%
  • Identify and target prospects that resemble your best (most profitable) customers
  • Improve personalization for personalized up-sell/cross-sell opportunities to increase frequency and their average order value
  • Launch an optimized mobile-friendly site to capture missed mobile sales

And this list can go on and on. This may be different from company to company but the idea is to identify areas that your business can improve that leas to maximizing Customer Lifetime Value. Each component of CLV will tell you something you can do for different cohorts/groups you’re evaluating.

Don’t like “leaving money on the table”? This is the perfect way to analyze all types of different customer cohorts and maximize their value where you can.

Final thoughts

Your business will greatly benefit from calculating, tracking, and maximizing Customer Lifetime Value. It’s not the number itself that provides you with much value. But using it to guide you to make profitable decisions on who and how to target  customers and prospects is the real benefit this provides.

Looking at different variables that make up Customer Lifetime Value you use to calculate also helps you see which areas in your business you need to work on to increase your revenue and profit.

And always segment your customers into different relevant groups and let your Customer Lifetime Value tell you the rest.

How to calculate Customer Lifetime Value

This is more complex than some might tell you, but calculating this properly will be well worth your time.

I’ll be publishing a separate article that breaks down different models of calculating both historical and predictive CLV and which method you should be using when.

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