Softrax

Customer Lifetime Value (CLV)

What is Customer Lifetime Value (CLV)?

Customer Lifetime Value (CLV), also known as Customer Lifetime Revenue (CLR) or Lifetime Customer Value (LCV), is a metric for the total expected revenue a business can earn from a customer throughout their entire relationship with the company. CLV is a valuable metric for assessing the long-term profitability and value of individual customers to a business.

What is the Formula for Customer Lifetime Value (CLV)?

The formula for CLV is:

Average Purchase Value x  Average Purchase Frequency x Average Customer Lifespan

  • Average Purchase Value: This represents the average amount of money a customer spends with a business during each transaction. To calculate it, a business sums the total revenue generated from all customer transactions and divides it by the total number of transactions.

  • Average Purchase Frequency: This is the average number of times a customer makes a purchase from a business within a specific period, such as a month or a year.

  • Average Customer Lifespan: This is the average length of time a customer continues to do business with a company. It’s typically calculated by dividing 1 by the churn rate, which is the rate at which customers stop doing business with you.

Customer Lifetime Value Calculation: Example

Suppose a business sells gaming apps and it wants to calculate the CLV of a typical customer. The business’ data for the past few years that shows the following:

Average Purchase Value (APV)
Purchase Frequency
Customer Lifespan (CL)
Gross Margin
$50
6 times per year
2 years
40%
  • Average Purchase Value (APV): The average amount a customer spends in a single purchase.
  • Purchase Frequency (PF): How often a customer makes a purchase in a year.
  • Customer Lifespan (CL): The average number of years a customer continues to buy from your store.
  • Gross Margin (GM): The profit the business makes from each sale, typically expressed as a percentage of the revenue.

To calculate the CLV for this gaming app business, use the following formula:

CLV = APV x PF x CL x GM

CLV = $50 x 6 x 2 x 0.40 = $240

So, the CLV of a typical customer in this example is $240. This means that, on average, this business can expect a customer to bring in $240 in profit over their entire relationship with this business.

What Does CLV Represent?

CLV is a powerful metric for several reasons:

  • Strategic Decision-Making: Understanding the CLV of your customers gives important insight that helps with determining marketing budgets, customer acquisition strategies, and retention efforts.

  • Profitability Assessment: CLV helps a business assess the overall profitability of its customer base. If the CLV is higher than the Customer Acquisition Cost (CAC), it indicates a profitable customer relationship.

  • Retention and Loyalty: By understanding the CLV, a business can identify opportunities to improve customer retention and build customer loyalty, as long-term customers tend to have higher CLVs.

  • Pricing Strategies: CLV can also inform pricing strategies, as it provides insights into how much customers are willing to pay for products or services over time.

What are some Customer Lifetime Value Metrics?

Important CLV metrics include:

Historical CLV: This is the traditional CLV calculation, which estimates the total value a customer has generated for your business up to a specific point in time. It’s calculated by summing up the historical revenue generated by the customer.

Predictive CLV: This metric forecasts the future value of a customer based on their past behavior and trends. Predictive CLV uses tools like statistical models, ML, or AI to make these forecasts.

Average Purchase Value (APV): APV represents the average amount a customer spends in a single transaction or order.

Purchase Frequency (PF): This metric measures how often a customer makes a purchase expressed over a specific time period.

Customer Lifespan (CL): The average duration a customer continues to engage with a business, often measured in terms of years.

Churn Rate: The percentage of customers who stop doing business with a company within a specific time frame. A lower churn rate generally leads to higher CLV.

Gross Margin (GM): This represents the profit margin on each sale. It’s often expressed as a percentage of the total revenue.

Discount Rate: The rate at which a company discounts future cash flows. It’s used in the net present value (NPV) calculation of CLV to account for the time value of money.

Customer Segmentation: CLV can be calculated for different customer segments or cohorts to identify the types of customers are the most valuable. Examples include first-time customers, loyal customers, or customers in different geographic regions.

Customer Acquisition Cost (CAC): This metric calculates how much it costs to acquire a new customer. Understanding CAC in relation to CLV helps assess the efficiency of a business’ customer acquisition strategies.

Net CLV: This takes into account both the revenue generated by the customer and the cost of acquiring and retaining them, providing a more accurate picture of the customer’s profitability.

CLV-to-CAC Ratio: This ratio compares the CLV to the CAC. A ratio greater than 1 indicates that a customer is profitable, while a ratio less than 1 suggests that customer acquisition is not cost-effective.

Cohort Analysis: This involves grouping customers based on when they first made a purchase and tracking the CLV of each cohort over time to identify trends and changes in customer behavior.

How Do You Increase CLV?

Increased CLV has direct tie-ins to providing excellent customer service, understanding the needs of customers, and setting up forums in which customer feedback can be gathered and implemented. Some tactics include:

Provide Excellent Customer Service: Outstanding customer service and support can  be two ways to build strong, long-lasting relationships with customers. Happy customers are more likely to make repeat purchases and refer others to a business.

Personalization: Personalized messages and marketing programs along with tailoring offers to customers’ preferences or past buying behavior are ways to boost CLV.

Loyalty Programs: Implement loyalty programs that reward customers for repeat purchases. This can include discounts, exclusive access, or points-based systems.

Upselling and Cross-Selling: Upselling and cross-selling are tactics that involve suggesting additional items or services when a customer is making a purchase. Ideally, the additional items would enhance their purchase.

Subscription Models: If applicable to, a business should consider offering subscription-based services or products. Subscriptions can provide a predictable revenue stream and encourage ongoing customer relationships.

Retention Marketing: This tactic involves focusing on retaining existing customers through email marketing, retargeting ads, and other retention strategies to keep a company top-of-mind.

Customer Feedback: Collect and act upon customer feedback to address issues and make improvements. This shows customers that a business values their opinions and is committed to their satisfaction.

Reduce Churn: A business should implement strategies to reduce customer churn, such as identifying at-risk customers and offering targeted incentives to keep them engaged.

Referral Programs: Encouraging satisfied customers to refer others to a business in exchange for rewards or discounts is a good way to boost CLV and gain additional customers.

Data Analysis: Continuously analyze customer data to identify trends, segment customers, and develop targeted marketing strategies and offers.

How to increase CLV

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