Let’s get this out of the way first before we move on to the heavy duty stuff. Now if you’ve been in the digital marketing field for some time now and your idea of fun is to read up on everything that is cooking in the world of digital marketing term, chances are you’ve heard of this term. If you’re a pro you might not need any explanation, but for those who’ve heard but haven’t understood it and for the recent additions to the school of digital marketing, this article is aimed at increasing your knowledge on this particular topic.
Customer Lifetime Value (CLV) is a measure of the total net profit a company makes from any given customer from their purchases over the entire life of the relationship between your business and the customer. Estimating a customer’s worth to a business in the monetary sense by factoring in the value of the relationship with a customer over time is what CLV helps you with. CLV helps you to calculate how much money a company should spend on acquiring new customers and how much repeat business a company can expect from certain customers.
If used properly, CLV which is also called CLTV, LCV and LTV, can prove to be a powerful piece of business intelligence that informs an efficient strategy for business growth and these calculations will also provide an indication against growth goals and gives a clear sign of the company’s worth.
Basically, it can be simplified to say that CLV is the value or worth of your average customer to the company. CLV gives you data through which you can understand and define the ideal customers for your business on whom the marketing and sales team can focus.
Let’s take this example of an online fashion retailer: A customer of the business spends Rs. 60,000/- annually on your website. This is the CLV. But now think about how much money it took to source this customer and how much was spent in servicing this customer. Even if you spent an average Rs.20, 000/- in services and about Rs.15,000/- in sourcing; meaning if you keep this customer longer than a period of 3 years you wouldn’t make any profit out of it and will just be breaking even and losing money too, so it makes sense to let go of this customer. CLV gives you this kind of data, basically, it means CLV gives you information on how profitable your customer is and if it makes sense to keep this customer on board.
And armed with all the information and insights that CLV gives you, you can strategize for acquiring new clients, targeting audience and marketing and advertising to them, the return on investments (ROI), efforts to retain customers, profit brought by every single customer, management strategies and profitability of the company. CLV scores are used to predict the future profits from a certain customer.
Customer Acquisition –
Based on what profit the new client will actually bring to your business and with the help of scores from Customer Lifetime Value (CLV) allocating a budget for your customer procurement becomes easier. It’ll help you to figure out the amount you can spend on customer acquisition.
Advertising and marketing objective –
You can understand the characteristics of each customer better and the data from CLV will also help you in building precise and detailed profiles for these customers. A company’s marketing team should always look to save money wherever possible and spend it wisely, CLV helps you focus on the customer segments that bring in the highest profit for your company and so you will be spending wisely and saving as well.
Return on Investment (ROI) –
ROI is an indication of the performance of your business; it gives you an insight into financial impact of your marketing efforts, and shows if there are any possibilities to make new investments and helps in identifying and eliminating those investments that might cost too much time, money, or resources to break even. While there are several tools to calculate ROI, CLV acts as a first-rate indicator of marketing campaign performance and provides accurate measurements. Often, with even restricted resources you’ll be able to get great returns.
Effect of management strategies –
The data from CLV can be utilized to promote a culture in the company which emphasizes customer satisfaction for the long-term, instead of concentrating just on short-term sales. You can learn the outcome on the worth of customer assets because of certain clever decisions.
Retaining Customers –
CLV scores help you in determining the amount your business should spend to hold on to specific customer segments. Because of this you can manage your customer relationships and keep it profitable as well. CLV also helps in gauging your customer’s loyalty, as well as key factors like frequency of purchase and probability.
Individual-customer profitability –
You’ll need to know how valuable or profitable each customer is to your business, this information is vital for your sales team because which they can concentrate on the most profitable new-customer demographic for a particular product/service and to identify opportunities for up-selling inside the existing customer base. And CLV data can be used to calculate the profitability of each customer.
Company profitability/valuation –
You need to know your company’s profitability or valuation to understand what’s doing well and where you need to change; for example, if you’re seeking extra funding or weighing up offers to buy-out you’ll need to know the value of your customer base, and expected growth. That is why CLV is a key data point in estimating the profitability of your company
How to calculate CLV?
You can calculate CLV by deducting the cost of obtaining and serving a customer from the returns gained from the customer. It also considers other factors such as money spent by the customer per visit, the total number of visits by the customer and then the average customer value for a week, a month, or a year, etc can be calculated. And the process is not only just that there are of course several other aspects which need to be taken into consideration.
Another simple way to calculate CLV is:
- The average length of time a customer buys from you, meaning the entire time period they stayed as your client.
- The number of transactions you have with an average customer in that time period, and
- The average amount of money spent per transaction.
Multiply all of them and you’ll have your CLV. But do ensure your original numbers are accurate because there will be a lot of junk which can skew the numbers!
But there’s a drawback here, companies usually end up neglecting to add or consider the changes in their marketing or advertising practices over time when they’re absorbed with what a customer has spent previously, and as result it shows a difference in the behaviour of new customers compared to old ones. You cannot and definitely should not dividing the total revenue by the number of total customers to calculate the CLV, as this very simple calculation does not take into account the length of time for which certain customers have had a relationship with the company. Any change in strategy or any kind of shift in the customer base of a company will prevent businesses from depending on past CLVs to predict future ones as a whole.
Alternatively, you can use these other more general ways of calculating a company’s CLV, check them out here below:
Average revenue for each user: To calculate a one- or two-year CLV, find out the average revenue of each customer per month and multiply that value by 12 or 24 (total revenue ÷ number of months since the customer joined). Though it is a simple approach to calculate CLV but does not take into account customer behaviour or any changes over time, either in preferences of customers or business strategy.
Analysis of Cohort: A group of customers that share a characteristic or set of characteristics is called a cohort. Instead of individual users by examining cohorts in your company, you’ll get a clear understanding of the changes that occur over the course of an entire relationship with groups of customers. But cohort analysis can be affected or distorted because of factors like market changes, seasonality and the introduction of new products, competitors or promotions.
Individual CLV: Some businesses do not focus on broadly calculating CLV but instead use sources like channel, campaign or other mediums such as coupons or landing pages on a company website they determine the total value of customers. Meaning they compare CLVs gained through social media advertising to those from obtained from other digital marketing campaigns, like, ascertaining whether resources are being efficiently spent in the company.
After calculating the CLV businesses should focus on using it as a benchmark to develop a pragmatic budget for customer acquisition or retention
- You discern that an average customer stays with you for 5 months.
- And buys something from your company thrice in a month.
- And per transaction, they spend an average of Rs.200/-.
So upon calculating, you know that your CLV is Rs.3000/- (5monthsX3times a monthXRs.200/- = Rs. 3000/-).
Based on this calculation, even if you spend Rs. 2000/ – on customer acquisition to gain one customer, there would be little, or no, profit (unless of course, your margins are outrageously high) left for you.
But if your customers hang on for 18 months, spend Rs.2000/- per transaction and purchase from you at least 10 times a month. Your CLV will be much higher at Rs.3, 60,000/- , your budget for customer acquisition can be increased significantly. Again, there are several other factors and different specifics which should be considered here which might change the CLV, like any costs associated with preserving this customer relationship hasn’t been taken into account and that would definitely change CLV. To arrive at an accurate number you should be realistic and include all those factors that apply as well.
Understanding your CLV is crucial and will channel your communication decisions! Even particular goals which are mentioned below:
- Getting an “x” number of new customers to the business.
- Increasing the number of transactions of your existing customers.
- Increasing the time period of the relationship between your customers and you, meaning how long they remain your customers.
- Increasing the monetary transactional value of each customer.
- Actual rates or a forecast of response and sales (easily available online or from any trustworthy advertiser) and the projected cost of media.
You’ll be in a good position to choose your action once you have all this information in your kitty.
Consider this example:
- I am a baking equipment retailer.
- This year I need to get 1000 new customers – this is the goal.
- I can get 200 customers without having to do anything (they’re probably referrals, walk- ins, etc.)
- So I need to have some kind of plan like advertising to acquire the remaining 800 customers.
- I can “buy” these 800 new customers by spending around Rs. 40,000/-..
- So then my CLV would be Rs. 40/-.
So now that I have my CLV, I decide to conduct a direct mail campaign after some contemplation. But the cost of printing and mailing the letters won’t leave me with a lot of room to maneuver, so what should I do?
- For the short term look at getting similar results from less expensive advertising means but are still effective.
- Don’t sacrifice the response and sale rates but you can still reduce the direct mail costs using several cost cutting methods like using just one colour instead of four, or a lighter paper stock.
- Look for ways to bolster the sales rates. For example you could enhance the offer and make it more attractive; mail to more people than you’d intended – this way you can get a wholesale price and you’ll acquire more customers too.
- Look to increase your customer’s average transaction amount by offering products with incentives.
- A strong retention program should be in place and aim at increasing the time your average customer stays on as your customer.
This is a very basic example to show how CLV works; you can still see why it is important to be aware of it. You’ll be speculating wildly on a lot of subjects without the help of CLV – possibly wasting money which could be used efficiently somewhere else or making huge mistakes that will impact your business negatively.
Before we conclude, you need to know that CLV can affect many different areas of the business given that it is not focused on gaining a lot of customers or gaining them cheaply. Instead, it emphasizes resourceful spending to capitalize on customer acquisition and retention practices. Your CLV can also be affected by Customer segmentation because certain groups of customers might be valued higher than others.