June 12, 2019
How to Calculate Customer Lifetime Value
Want to acquire and retain highly valuable customers? You’ll need to get your head around customer lifetime value (CLV).
CLV refers to the value a customer contributes to your business over their entire lifetime. It’s one of the most important metrics you’ll come across as a marketer, especially if you work for a company currently in its growth stage. Measuring your CLV relative to the cost of customer acquisition (CAC) allows you to calculate how long it takes to recoup the investment required to earn a new customer (for example, cost of sales and marketing).
Why you should care about CLV
Studies have shown that it’s more costly to acquire new customers than it is to retain existing ones. According to the Harvard Business Review, gaining a customer can cost between 5 to 25 times more than retaining an existing one. Additionally, a Bain & Company study found that a 5% increase in retention rate can lead to an increase in profit between 25% to 95%. Therefore, it’s important to extend your CLV to ensure the success of your marketing and customer retention strategy.
How to calculate CLV
Let’s break it down. Imagine you own an e-commerce website selling Napa Valley wines. For simplicity’s sake, let’s assume that your business has 5 regular customers.
Here are the steps you must take to calculate your business’ CLV:
Calculate average purchase value (A)
The first step involves calculating your customer’s average purchase value. This is done by averaging how much a customer spends on each visit during a specific time period, whether it be a week, month or year. In this scenario, let’s say we want to calculate your monthly CLV.
Example: Customer A may visit your website three times a month, spending $240 all up. His average purchase value would be $80 per month. Once we determine the average purchase value for the first customer, we can do the same for your remaining customers (shown in the table below).
|Visits per month||Total monthly spend||Average purchase value|
We will then add each average together (so, 80 + 75 + 90 +70 + 50 = 365), then divide that amount by the number of customers (in this case, 5) to get an average purchase value of $73.
Calculate average purchase frequency rate (B)
Step 2 involves measuring the average purchase frequency rate. We divide the number of purchases across the selected time period by the number of unique customers who bought from you during that time.
Example: In the case of your wine business, we’ll need to find out how many visits the average customer makes to your website in a month; a website tracker can help with this. Using the table in A, we can add up all the visits made in a month and divide the figure by 5. So, 3 + 2 + 1 + 3 +4 = 13; 13 divided by 5 is 2.6 so our average purchase frequency rate is 2.6.
Calculate average customer value (C)
We now know how much your average customer spends and how many times they are likely to visit your website each month. We can now work out their customer value.
This involves looking at all your customers individually; we multiply their individual average purchase value (from the table in A) by the average purchase frequency rate determined in B. The customer value tells us how much money each customer is worth to your business per month.
Example: The following table tells us what each customer brings to your business each month.
|Average purchase value||Average purchase frequency rate||Customer value|
To calculate the average customer value, add each customer value and divide the total by 5. So, 208 + 195 + 234 + 182 + 130 = 949 divided by 5 gives us an average customer value of $189.80.
Calculate average customer lifespan (D)
Step 4 is tricky because we cannot accurately predict how long a customer will continue to buy from your business. There are several ways you can calculate average lifespan; you can look at historical data or you can divide 1 by your churn rate percentage.
Example: The average online shopper stays loyal to one brand for 20 years. For simplicity’s sake, let’s say that your average customer will buy from your website for the next 20 years.
Calculate CLV (E)
Now that we know how to work out the average customer value (C) and average customer lifespan (D), we can finally calculate CLV.
We do this by multiplying the average customer value (C) by
- The frequency of the specified time frame within a year; and
- The average customer lifespan (D)
In this example, we are measuring our customers’ monthly shopping habits, so we must multiply their customer value by 12 to reflect an annual average. If you set your time period to a week, then you’d multiply their customer value by 52 and so on. After that, multiply this number by the customer lifespan value to get the CLV.
Example: We worked out that the average customer value was $189.80 in (C); we multiply that by 12 (as we are measuring their monthly habits) and then by the average customer lifespan value (20) to get a CLV of $45,552 ($189.80 x 12 x 20 = $45,552).
The CLV gives you an estimate of how much revenue you can reasonably expect an average customer to generate for your business over the course of their relationship with you.
How to increase CLV
Not entirely happy with your CLV? The good news is that you can improve it. Here are 2 ways you can do that:
We know that customer acquisition is not cheap. This makes it imperative that your business identifies and nurtures the most valuable customers that interact with your brand.
Finally, the happier your customers are, the more likely they are to spend more money on your website. And businesses that are actively geared towards creating a memorable customer experience are more likely to generate higher revenue because of increased customer satisfaction.