What is Customer Lifetime Value (CLV)?
Customer Lifetime Value (CLV) is a customer’s total profit value to your company throughout the time they are your customer. CLV includes all the money they have spent, will spend, and the potential referrals to other prospective clients.
CLV calculates and tells you the profit expected from a customer, which helps you know how much you should invest in them. Customer lifetime value also gives you insights into whether your customers will renew their contract and how much more you could upsell or cross-sell to them.
Using analytics to calculate customer lifetime value, you can improve your business strategies for getting new clients and retaining existing ones.
Why Is Customer Lifetime Value Important?
Businesses cannot ignore the value of the CLV. If you calculate your customer lifetime value, you will understand your customer’s behavior. This will lead to creative new ideas and ways of doing upsells, leading to more profit.
Other pros of using customer lifetime value include;
- You get to know how much time it will take before the customer relationship becomes profitable. This lets you know at what point the revenue earned from them exceeds the cost you invested in gaining them as a customer.
- You get to know when you’re losing money – when the cost of maintaining the customer outweighs its value.
- Learning which segments or personas of your clients are most profitable
With the above information, you can now easily;
- Predict your revenue and use the prediction for business planning
- Plan how much to spend to acquire customers
- Take advantage of new avenues and opportunities to increase customer lifetime value over time.
How To Calculate CLV
If you have a complicated product and little information, it will be hard to calculate CLV. This means that large companies may have difficulty calculating CLV due to complex products, untargeted marketing, and segregated teams. However, with a bit of effort, you can calculate your CLV.
There are two methods to calculate the CLV:
Aggregate Model — This model uses the average revenue per customer (based on past transactions) to calculate the CLV. Using the aggregate method, you get a single CLV value.
Cohort Model — This model groups customers into different cohorts based on various factors, e.g., transaction date. It then calculates the average revenue per cohort, giving a CLV value for each cohort.
Machine Learning Model — This model predicts the CLV by using regression techniques to analyze past data.
Probabilistic Model — This model uses a probability distribution for the data and predicts the future count and monetary value of transactions.
CLV Through Customer Segmentation
You can calculate CLV If you segment the customer base using demographic, revenue, geographic, and behavioral segmentation factors.
Using segmentation while calculating the customer lifetime value helps companies to define and target their best customers.
If you have used customer segmentation, you can use the following formula to calculate the CLV.
Approaches To Calculating CLV
The historical method is based on the gross profit sum that your customers have purchased from you in the past. For this calculation, you only need data from previous purchases. However, you should note that the historical method is valid only if your clients have similar preferences and stay in your company within the same period.
The historical method doesn’t consider changes in customer behavior, so if your customers change the way they purchase items and their interests, the outcome will be varied and different.
The Cohort method uses the average revenue per user (ARPU) approach. A cohort is defined as a group of clients who have similar characteristics. This means that they are mostly in the same place in their customer journey and have made their first purchase during the same month. By doing cohort analysis, you can calculate the average revenue per cohort instead of per user.
Another advantage of cohort analysis is that it can help you accurately assess your Ad campaign performance and find the precise number of loyal clients. You can improve the customer lifetime value by finding the points where purchasing drops off.
However, a more accurate method of calculating CLV is the predictive approach.
The predictive approach uses a customer’s transactional behavior to predict what they’re likely to do in the future. This means it uses algorithms to comb through the data and predict the total value of a buyer. Using past purchases helps you to learn more about the client’s actions.
Though the predictive approach is accurate than the historical model, you still need to be cautious. Why? The predictions may be misleading. This is because you’re simply guessing the customer lifespan based on monthly data. To get a more accurate result, you should adjust the CLV formula to your business strategy and specific industry.
The Customer Lifetime Value (CLV) Formula
While calculating the CLV, you need to know that for each customer that you have, the CLV is the sum of three estimates:
Customer Lifetime Value = Current Value + Future Value + Referral Value
Current Value = Sum of Revenue – Cost
The Future Value is the estimated time that the customer will stay with your company. You can get the future value by using the customer retention rate.
Here’s the formula for getting the customer retention rate.
Average Customer Lifetime = 1/Churn Rate
Future Value is also affected by another critical factor; spending – how much money the customer will spend increases or decreases with time.
Can you improve your CLV.? Definitely, yes. During your business development, you should always make sure you are improving your CLV. But first, you need to learn how to improve this metric.
The first thing you should know is that if your customer lifetime value (CLV) is three times your Customer Acquisition Ratio (CAC), your business is doing well; if it’s lower, you need to work on your CLV.
To improve your CLV figures, you need to continually improve your customer-brand connection. This means increasing customer loyalty so that your relationship with the customer lasts long and is mutually beneficial to both parties.
To improve your customer loyalty, do the following;
- Start rewarding your customers.
Customers want to feel appreciated. You can use a variety of ways to reward them. For instance, you can create a loyalty program that awards customers points using their cards or mobile applications. Using the awarded points, your customers can get personal discounts and other benefits.
- Improve your customer experience
Customers evaluate every interaction they have with your business. They then make judgments (some bad, that can be hard to shake off if not addressed early). Therefore, each touchpoint (online and offline) with customers should be monitored and continuously updated to reflect your company’s values and enhance customer experience.
Also, listening to customers is essential. They may spot errors in your system that you may have missed. Customers want to be heard. Therefore, listen to your customers and make the appropriate changes.
- Offer convenience
If you simplify your customers’ life or job, they’ll keep coming back. This means that you should continually evaluate and upgrade your customer experience to make it easy for your customers to buy products or services.
A good place to start is improving your checkout and billing. Also, make sure your social media pages are continually monitored so that you can interact with your clients on social media.
In this blog, you’ve learned that Customer lifetime value (CLV) is a customer’s total profit value to your company throughout the time they are your customer. This includes all the money they’ve spent in the past, the money they’ll spend in the future, and potential referrals to other prospective clients.
CLV helps you learn precisely how much money you need to invest in retaining your existing customers and acquiring new ones. You can use CLV to get ideas of how to build customer loyalty and increase sales. CLV improves your business by helping you know exactly who the top clients are and what to do to make other customers spend more.