How to determine customer lifetime value

In marketing, we often place a primary focus on the cost of acquisition, or how much it will cost to close each sale.

Yet customer lifetime value (CLV) is equally important as a metric of success. By tracking CLV, you can gain a greater understanding of the user journey.

What drives customers to become repeat buyers or loyal subscribers? How can you maximize your marketing efforts to entice higher value customers? Here’s why customer lifetime value should be one of your key metrics.

What is customer lifetime value?

Customer lifetime value, or CLV, is a figure showing the amount of money that a customer spends with your business throughout the duration of your relationship. For example, a customer might sign up for a subscription service that costs $120 each year for a total of five years. To acquire this customer, you spent $10 on advertising. The customer’s lifetime value would equal the total customer expenditure, minus the acquisition cost – in this case, $590.

What does CLV show you? It measures how valuable the customer is to your business over time. Yet it also indicates how successful you are at delivering a positive customer experience. Higher CLV values show that you’re building a loyal, stable customer base with the relationships – and revenues – to match.

Why is CLV important?

It costs far more to acquire a new customer than it does to retain an existing one. Tracking customer lifetime value not only shows you just how much each customer brings into your business, but it also helps you track growth. As your average CLV increases, your business possibilities grow accordingly, since you have more money to reinvest.

CLV is particularly useful for businesses engaging in multi-year contracts or long-term relationships. If you see average spend dropping after the first year of engagement, it provides an early warning of dissatisfaction and allows you to turn it around with improvements to the customer experience at key touchpoints. Essentially, CLV shows you how valuable the customer is to your business over time. As customer loyalty grows, you’ll have higher-value customers as a result.

Customer lifetime value calculation and formula

When it comes to calculating CLV, there are several methods to choose from. One option is to use historic sales data as the basis for lifetime value calculation. Another is to predict what customers will spend in the future.

To calculate historic CLV, simply add up the total value of transactions and multiply this figure by your average gross margin.

The predictive customer lifetime value formula is slightly more complex, but it accounts for variations in behavior and is more accurate as a result.

For a predictive lifetime value calculation, you’ll need to gather the following data points first:

  • Average Order Value (AOV) = Total Sales Revenue / Total Number of Orders
  • Gross Margin (GM) = (Total Sales Revenue – Cost of Goods Sold) / Total Sales Revenue
  • Churn Rate (CR) = (Number of Ending Customers – Number of Starting Customers) / Number of Starting Customers
  • Customer Lifetime Period = 1/CR
  • Purchase Frequency (F) = Total Number of Orders / Total Number of Customers

Once you’ve worked out these various figures, you’ll be able to plug them into the customer lifetime value formula below:

CLV = AOV x F x GM x (1/CR)

For example, imagine that your company has a total sales revenue of $200,000, with a total number of 1,000 orders.

  • The Average Order Value would be (200,000 / 1,000), or $200.
  • You have 500 customers, so your Purchase Frequency is (1,000 / 500), or 2.
  • Your Cost of Goods Sold is $40,000, which means that your Gross Margin is (200,000 – 40,000 / 200,000) or 0.8.
  • You have a Churn Rate of 15%, for a Customer Lifetime Period of (1 / 0.15) or 6.67.

Input these figures into the customer lifetime value formula:

CLV = 200 x 2 x 0.8 x 6.67

The total lifetime value per customer is therefore $2,134.40

How to improve CLV

Companies that are able to build long-term, positive relationships with their customers will see this reflected in higher customer lifetime values. Keeping this in mind, here are a few top tips to give your average CLV a boost.

1. Analyze the user experience

CLV is a fundamental measure of user experience which can be clearly mapped through each of its stages. You can map each stage of the customer’s journey beginning with initial lead generation, on to conversion, retention, and eventually churn. There are multiple touchpoints along the way which help forge the relationship between a brand and its customers. Advertising and social media reach along with affiliate marketing might capture initial attention, but these must be followed up with customer service, points of sale, and product use. A good way to improve customer lifetime value is to monitor this journey, listen to feedback, and make changes when required.

2. Use a customer loyalty program

While customer loyalty can arise from the strength of your products, a quick way to boost retention rates is through a managed loyalty program. Give customers incentive to continue doing business with you by offering special discounts, VIP rewards and additional benefits. From loyalty apps to bonus points, little perks can make a world of difference in CLV.

3. Target your marketing efforts

Once you’ve set up a customer experience management program, you’ll be able to craft a more fine-tuned and targeted marketing plan to match. Using historic CLV data alongside demographic details, you can segment your customer base to target more effectively those with higher value. ShareASale’s merchant tools help you pinpoint the marketing activities most likely to boost value, with a data-driven approach to customer segmentation.

4. Apply machine learning insights

Make data the underlying basis for affiliate marketing efforts and reach out to your target audience more effectively. In addition to segmentation, businesses can also use machine learning insights to discover related products that your highest value customers are most likely to purchase. You can spot trends in buying behaviors using association analysis. By pooling together related products and working with relevant affiliate partners, you can take a proactive approach to boost sales for higher CLV.

5. Time communications carefully

Finally, timing is everything in marketing, particularly for affiliate merchants. You’ve drilled down into the data to find out what your high value customers want. Yet it’s also important to reach them at the right time. Analyze the factors most likely to impact customer churn and send your messaging at the best stage of the customer journey. For example, a recipe subscription box might find out that their customers are likely to drop off after the three-month trial period. The best time to step up marketing efforts with tactics like affiliate advertising would be right before this trial period ends.

By taking a multi-channel approach to customer lifetime value and its associated data, you can more effectively meet your customers’ needs while fueling profit at the same time.

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