CLV (customer lifetime value) refers to the amount of money that a customer will spend on your products or services over their lifetime. It can also be referred to as the monetary benefit they bring to your company. If you have a bookstore, what amount do you expect customers to spend on your store throughout your relationship? How does that differ from people who buy mystery books or comic books? What is the average cost of maintaining and fixing cars for customers who own a car repair shop? How does that compare to someone who has a minivan or someone who has a sports car? To get a better understanding of their value, companies should assign customers a dollar amount based on their estimated spending.

Why Is Customer Lifetime Value So Important?

Your business’s customer lifetime value is crucial because it answers key questions that will determine your future strategic decisions.

  • What amount do you need to spend to retain, engage and acquire customers?
  • Is it more expensive to maintain a relationship with customers than their CLV?
  • Which products or services are most profitable?
  • How do your marketing strategies and business strategies impact the financial results?

Understanding Customer Lifetime Value Is A Benefit

Knowing your CLV will give you a better understanding of your business’s profitability. This helps you to identify ways to improve your return on investment (ROI) and lower your customer acquisition costs. New customers have significantly higher costs and lower profit margins. However, repeat customers are much more affordable and easier to retain. A study has shown that increasing customer retention by 5% can result in a 95% increase in profits. Companies can increase customer retention by understanding their CLV. This will help them to improve their revenue and sales.

A significant increase in ROI results in a steady stream of cash and a higher profit margin. Companies that invest in their CLV by anticipating their customers’ needs and meeting them with their services, see increased profits and reinvest these profits back into their business. Knowing the customer’s lifetime value can help you to find additional resources for product development, product research, team expansion, and business development.

Building Great Businesses helps to determine which products or services are the most profitable and result in the greatest customer retention. Customers will return to the company if they buy products in large numbers and frequently. CLV can also help identify areas for improvement. A low customer lifetime value could indicate poor customer service or product quality.

Finally, customer lifetime value allows you to see the impact of your marketing strategies and business decisions. Is your product more successful in bringing in new customers than it is in bringing back customers? Your latest ad campaign was less expensive than the value of potential customers it acquired. Marketers can use CLV and other metrics such as conversion rates and CAC to get an idea of what works, who it worked for, and what needs adjustment before moving on.

How To Calculate Customer’s Lifetime Value?

There are two types of CLV models: historical and predictive. Historical CLV uses average purchase values to look at historical data but doesn’t take into account customer journeys. Predictive CLV is focused on forecasting both new and existing customers’ value and can help understand profitability as well as improve customer retention.

You need to calculate the following to calculate the customer’s lifetime value:

Average Purchase Value: Total Revenue divided by the Number of Purchases

Average Purchase Frequency: Number of purchases divided by the number of customers who have made purchases

Customer Value: average Purchase Value multiplied by average Purchase Frequency Rate

Average Customer Lifespan: Sum of customer lifetimes divided by the number of customers

The customer lifetime value simply represents customer value multiplied by the average customer’s lifespan. This will give you an estimate of the revenue that your average customer should generate over the life of their relationship.