Most owners understand that their customers are integral to their business’ success, but not many can actually place a value on each, or the average, customer. This is why the concept of customer lifetime value, or CLV, is so important. A business that calculates and tracks its customer lifetime value is able to realign processes, maximize efficiency, and take a more realistic view of future cash flows.
Why Customer Lifetime Value Matters to Your Business
Businesses calculate their customer lifetime value to better understand new customer acquisition costs and estimate future returns per acquired customer. This allows business owners and operators to shift resources toward those activities that most effectively attract, retain, and extract value from customers.
In a sense, focusing on CLV helps turn customer activity into a data-driven asset class. It may sound impersonal, but it can be a very powerful tool for delivering the best and most valuable experiences to your potential consumer base; people are willing to spend the most money and are drawn in most easily by those products and services to which they genuinely attribute the highest value.
When your business can approximate the lifetime value of its customers, you’ll find it much easier to project future cash flow and income by extrapolating your conversion rates, retention rates, and average revenue into upcoming finance periods.
How to Calculate Customer Lifetime Value
Accurately measuring customer lifetime value is not as simple as comparing incoming revenue to conversion costs, and there is no universally applicable formula for calculating it.
If you search the internet, you’ll find a long list of simple, easy-to-implement CLV formulas or estimators. The difficulty with these solutions is that customer behaviours are not easy to predict, and your business might attract many kinds of consumer archetypes.
It is still useful to attempt a CLV calculation when you are uncertain about specific behaviours, however, because even approximations about acquisition costs and lifetime value capture can help you make better business decisions.
Some of your customers, your best ones, have relatively high lifetime value. Others may have a negative lifetime value depending on how much time and money it took to engage them and how much revenue you generated from them.
The following is a workable formula for many business owners:
Customer Lifetime Value = (average number of years a customer is active) x (average annual customer contribution)
To calculate net CLV, simply subtract the average cost of acquiring and servicing your customers. Think in terms of marketing, time spent acquiring, customer support, and other expenses.
Recency, Frequency, and Monetary Value
Most CLV guides identify three variables that should be tracked for your customers. These are:
- Monetary value
Higher customer lifetime values correlate with longer periods of time making purchases, higher frequency of purchases, and more money spent per purchase. The idea is to use this information to segregate your customers into high-, medium-, and low-value groups. From there, calculate the CLV for each segment.