Customer lifetime value (CLV) is a crucial metric for businesses of any size. It provides insight into the total revenue a business can expect from a single customer account throughout the business relationship, taking into account the customer's revenue value and the company's predicted customer lifespan.
In this guide, we will walk you through the steps to calculate customer lifetime value, including what data you need and how to interpret the result. We'll also provide strategies for improving your CLV and optimizing your business's revenue potential.
What is Customer Lifetime Value?
Customer lifetime value, or CLV, is a metric that indicates the total revenue a business can reasonably expect from a single customer account throughout the business relationship. It considers a customer's revenue value and compares that number to the company's predicted customer lifespan.
The longer a customer continues to purchase from a company, the greater their lifetime value becomes. Therefore, customer support and success teams can directly influence CLV during the customer's journey.
Why is Customer Lifetime Value Important?
CLV is an important metric for businesses because it helps gauge financial viability and can improve customer retention with a data-driven understanding of what existing customers find valuable from your business.
By calculating CLV at different levels (company-wide, customer segment, individual customer), businesses can identify areas for improvement and create targeted strategies to increase customer lifetime value.
Components of Customer Lifetime Value Calculation
Calculating CLV involves three main components: average purchase value, average number of purchases, and average customer lifespan. We'll explore each of these in more detail below.
How To Calculate Average Purchase Value
The first step in calculating CLV is to determine the average purchase value, or APV. This is the total revenue earned in a specific time period (usually one year) divided by the total number of sales generated during that same period.
How to Calculate Average Purchase Value
To calculate APV, simply divide your business's total revenue in a specific period by the number of purchases made during that same period.
Formula for Calculating Average Purchase Value:
Average Purchase Value = (Total Value of Orders) / (Number of Orders over a Defined Period)
Example #1, If your business generated $20,000 in revenue in a month from 200 sales.
APV = $20,000 / 200 = $100
Example #2, Let's say a business wants to calculate its APV for the month of June. During this month, the company had a total revenue of $50,000 from 20 transactions.
APV = $50,000 / 20 = $2,500
In this example, the Average Purchase Value for the month of June is $2,500. This means that, on average, customers spent $2,500 per transaction during this period.
Tracking this metric over time, businesses can monitor changes in customer spending habits and adjust their strategies accordingly to maximize revenue.
Why Average Purchase Value Matters
APV is an important metric because it provides insight into the average amount of money a customer spends per transaction. By increasing the APV, businesses can increase their revenue potential without necessarily increasing the number of customers or transactions.
Average Number of Purchases
The second component of CLV is the average number of purchases, or ANP. This is the number of purchases made by the number of unique customers during a specific time period.
How to Estimate Average Number of Purchases
To estimate ANP, divide the number of purchases made during a specific time period by the number of unique customers who made purchases during that same period.
Formula for Calculating Average Number of Purchases:
Average Number of Purchases = Total Number of Purchases / Number of Unique Customers
Example #1, if your business had 200 sales in a month, but only 100 unique customers made those purchases.
ANP = 200 / 100 = 2
Average Number of Purchases = 2
Example #2, Suppose a business has a total revenue of $50,000 during a one-year period and records 1,000 purchases made by 250 unique customers.
ANP = 1,000 (Total Number of Purchases) / 250 (Number of Unique Customers)
Average Number of Purchases = 4
In this example, the average number of purchases per customer is 4. This means that, on average, each unique customer made 4 purchases during the one-year period.
Why Average Number of Purchases Matters
ANP is important because it provides insight into the average frequency of customer transactions. By increasing ANP, businesses can increase their revenue potential without necessarily increasing the number of customers or the APV.
Average Customer Lifespan
The third component of CLV is the average customer lifespan, or ACL. This is the average number of years a customer continues purchasing from your company.
How to Determine Average Customer Lifespan
To determine ACL, calculate the time between the customer's first purchase and their last purchase (or predicted last purchase). Alternatively, you can estimate ACL based on industry benchmarks or historical data.
Formula for Calculating Average Customer Lifespan:
Average Customer Lifespan (ACL) = Sum of Customer Lifespans / Number of Customers
Example: Let's assume a business has five customers with the following lifespans:
Customer 1: 4 years
Customer 2: 3 years
Customer 3: 5 years
Customer 4: 2 years
Customer 5: 6 years
To calculate the ACL, we first need to find the sum of all customer lifespans:
Sum of Customer Lifespans = 4 + 3 + 5 + 2 + 6 = 20 years
Next, we divide the sum by the total number of customers:
Average Customer Lifespan (ACL) = 20 years / 5 customers = 4 years
In this example, the Average Customer Lifespan for the business is 4 years. This means that, on average, a customer remains actively engaged with the business for 4 years before becoming dormant or dropping off.
Why Average Customer Lifespan Matters
ACL is important because it provides insight into the longevity of customer relationships. By increasing ACL, businesses can increase their revenue potential over the long term.
Calculating Customer Lifetime Value
Once you have the necessary data for APV, ANP, and ACL,you can calculate customer lifetime value using the following formula:
Customer Value Formula
Customer Lifetime Value (CLV) = (Customer Value * Average Customer Lifespan)
Customer Value = (Average Purchase Value x Average Number of Purchases)
Step-by-Step Guide to Using the Customer Value Formula
- Calculate the average purchase value (APV): Calculate the average amount a customer spends on each purchase by dividing the total revenue generated during a specific period by the total number of orders placed during that period.For example, if your business generated $10,000 in revenue from 200 orders in a month, the APV would be $50 ($10,000 / 200).
- Estimate the average number of purchases (ANP): Determine the average number of times a customer makes a purchase during a specific period. You can do this by dividing the total number of transactions by the total number of unique customers during that period.For example, if your business had 500 transactions from 250 unique customers in a month, the average number of purchases (or transactions) per customer would be 2 (500 / 250).
- Multiply APV by ANP
- Calculate the average customer lifespan (ACL) = Sum of Customer Lifespans / Number of Customers
- Multiply customer value by ACL to calculate customer lifetime value (CLV): Calculate Customer Lifetime Value (CLV): Multiply the average purchase value (APV), average number of purchases per period (ANP), and average customer lifespan (ACL) to determine the CLV. For example, if your APV is $50, the average number of purchases per customer is 2, and the average customer lifespan is 3 years, the CLV would be $300 ($50 x 2 x 3).
Understanding the Result
Since you've calculated CLV, it's important to understand what the result is telling you about your business. The resulting CLV is a monetary value (depending on the currency you work in) and shows how much you can reasonably expect the average customer to spend with you over their lifetime.
What CLV Tells You About Your Business
CLV provides valuable insight into the overall health of your customer relationships and your business's revenue potential. A high CLV indicates that customers are likely to continue purchasing from you, while a low CLV suggests that customers may not be as loyal or engaged.
Additionally, CLV can help you identify which customer segments are most valuable to your business, allowing you to create targeted marketing strategies and optimize resources for maximum impact.
Interpreting Different CLV Results
It's important to remember that CLV is a dynamic metric and can change over time. Regularly recalculating CLV can help you identify trends, monitor the effectiveness of your strategies, and adjust accordingly.
Considerations for CLV Calculation
There are several factors to consider when calculating CLV to ensure accuracy and relevancy:
Using Predictive Analytics for CLV
Predictive analytics can help reduce the margin of error in CLV calculations by using historical data and advanced algorithms toforecast future customer behavior. This can result in a more accurate and actionable CLV figure, allowing you to make data-driven decisions for your business.
Accounting for Total Costs in CLV
In addition to revenue, it's important to consider the total costs of acquiring and serving customers when calculating CLV. By factoring in costs such as marketing, sales, support, and product development, you can gain a more comprehensive understanding of the true value each customer brings to your business.
Improving Customer Lifetime Value
Once you have a clear understanding of your business's CLV, you can implement strategies to improve it. Here are some suggestions for increasing average purchase value, average number of purchases, and average customer lifespan:
Strategies for Increasing Average Purchase Value
- Offer upsells, cross-sells, or bundled products to encourage customers to spend more per transaction.
- Implement a loyalty program that rewards customers for higher spending.
- Focus on providing exceptional customer service to increase perceived value and justify higher prices.
- Regularly review and optimize your pricing strategy to ensure it reflects the value you provide and remains competitive in the market.
Strategies for Increasing Average Number of Purchases
- Implement a subscription-based model or offer recurring purchases to encourage repeat business.
- Create targeted marketing campaigns to remind customers of your products and services and entice them to make additional purchases.
- Offer personalized product recommendations based on customer preferences and purchase history.
- Encourage referrals and word-of-mouth marketing to attract new customers and increase overall transaction volume.
Strategies for Increasing Average Customer Lifespan
- Focus on building strong relationships with your customers through personalized communication and exceptional customer service.
- Continuously improve and expand your product or service offerings to keep customers engaged and satisfied.
- Offer loyalty programs or rewards to incentivize long-term commitment from customers.
- Regularly seek customer feedback and address any concerns or issues promptly to maintain trust and loyalty.
Bottom Line
Calculating and understanding customer lifetime value is essential for any business looking to optimize its revenue potential, build lasting customer relationships, and allocate resources effectively. Keep in mind that CLV is a dynamic metric and should be regularly monitored to ensure your strategies remain effective and relevant.
