Why Customer Lifetime Value Is the Most Crucial Metric for Your Business

Contributors: Manjusha Karkera
Published: January 2, 2023

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Introduction to Customer Lifetime

Apart from the most apparent metrics businesses focus on, one of the most crucial metrics to determine a business’s financial gains and losses is to be completely aware of what value customers bring to one’s business. In order to understand how marketing is performing, it is important that the customers be retained for a more extended period, and this is known as customer lifetime. 

The health of a subscription business is determined by Customer Lifetime Value (CLV). Every customer is important, but when seen from a more significant point of view, companies understand that some customers tend to hold more value than the rest. And the most straightforward way to retain those customers and increase their loyalty is by calculating their Customer Lifetime Value (CLV). Customer Lifetime Value is an essential concept for marketing, sales and ultimately for the overall growth of the business.

What exactly is Customer Lifetime Value (CLV)?

Customer Lifetime Value is the revenue that a customer spends in return for the products and services offered by a company over a lifetime. How businesses approach Customer Lifetime Value defines their businesses, which could significantly vary depending on what a company or business is looking for. 

An increase in CLV means that a particular product offered by the company is market fit and that the businesses have recurring revenue from its existing customers. With the help of CLV, businesses can also optimize their acquisition spending. Through CLV, companies can design a well-planned strategy with proper and brief budget planning.

How is Customer Lifetime Value (CLV) calculated?

There are quite a few ways to calculate Customer Lifetime Value (CLV), which can either be predictive or historic. This means that businesses can calculate CLV based on the customer’s purchases over the years or on the predictions of how much the customers will spend. CLV calculation differs based on the business model, however, calculating CLV is more straightforward if the model is subscription based. 

Below mentioned are the factors that are required in order to calculate Customer Lifetime Value:

– Average purchase frequency rate

– Average purchase value

– Customer value 

– Average Customer Lifespan

Customer value multiplied by average customer lifespan will give you Customer Lifetime Value (CLV). This means the approximation of revenue that a business can expect from an average customer over the course of their relationship.

The five-step process to acquire Customer Lifetime Value is as follows:

  1. Find the Average Purchase Value (Divide total revenue by the number of purchases)
  2. Next, find the Average Purchase Frequency Rate (Divide the total number of purchases by the number of individual customers making the purchase)
  3. Find Customer Value (Multiply average purchase value with average purchase frequency rate)
  4. Find the Average Customer Lifespan (The sum of customer lifespans is divided by the total number of customers)
  5. Lastly, find the Customer Lifetime Value (For this, the customer value is simply multiplied by the average customer lifespan)

Calculating Customer Lifetime Value (CLV)

Customer Lifetime Value (CLV) is given as:

CLV = Average Purchase Value x Average Purchase Frequency Rate x Average Customer Lifespan

Where,

Average Purchase Value = Total Revenue Earned / Number of Transactions

Average Purchase Frequency Rate = Number of Orders Placed / Number of Unique Customers

Customer Value = Average Purchase Value x Average Purchase Frequency Rate

Average Customer Lifespan = Number of years over which a customer purchases from a business and then find the average.

Let us now take a hypothetical company’s example to calculate the (CLV) customer lifetime value of a customer.

The average sale of a shoe retailer is $50, and the average a customer shops with them is four times per year for two years.

So the lifetime value of this customer becomes:

Lifetime Value = $50 x 4 x 2

= $400

After calculating the cost of goods, and other additional expenses, the company’s profit margin remains to be 20%, so the customer lifetime value (CLV) here becomes:

Customer Lifetime Value (CLV) = $50 x 4 x 2 x 20%

= $400 x 20%

=$80

This value is the cash flow that a company will be gaining, and this allows them to understand how many customers they should aim for in order to reach their threshold of profitability.

Importance of Customer Lifetime Value (CLV) 

Customer Lifetime Value is vital for businesses as it determines the financial value of every customer individually. CLV is the heart of e-commerce businesses as it is a unique strategy that does not involve short-term sales. 

Customer Lifetime Value (CLV) enables businesses to know some crucial sales and marketing strategies of their business model, which involves upselling, cross-selling, retention, acquisition, and more. CLV helps a business decide the amount of money required to be spent on a particular customer in order to acquire them.

Through Customer Lifetime Value (CLV), businesses can understand customer behavior in a better and more proactive manner.

Another, most valuable part of customer segmentation is that businesses get a lookalike model through which they can gain more high-value customers and extend special offers and discounts to them to retain existing customers for a longer period. 

Final Takeaway on Customer Lifetime Value (CLV)

 One of the most crucial metrics businesses can focus on as a part of their marketing and sales strategy is Customer Lifetime Value (CLV). CLV not only creates and huge and noticeable impact on customer retention rates but also reveals the brand loyalty of a business or a company. 

For an e-commerce business, it has become more important to segment the customer base and improve brand loyalty rather than gain new customers. The prime focus should always be kept on retaining existing customers, not just acquiring new ones. CLV helps businesses understand their profitability and learn how impactful their business decisions are in creating brand awareness and engagement.

FAQs

1. How do you calculate the lifetime value of a customer?

Customer Lifetime Value is the most crucial metric determining which customers spend the most at your businesses. By multiplying a customer’s average purchase plan, average purchase frequency, and average customer lifespan, Customer Lifetime Value (CLV) can be calculated.

2. What is the formula for customer value?

Simply put, customer value can be stated as follows:

Customer Lifetime Value = (Average Customer Lifespan * Customer Value)

Where Customer Value = (Average Number of Purchases * Average Purchase Value)

Other Startup KPI Metrics

Understanding and Maximizing Monthly Recurring Revenue

The ARR Advantage for Startups: Understanding and Calculating Annual Recurring Revenue

Using ACV to Measure the Success of Your Sales and Marketing Efforts

Total Contract Value – A Key Metric for Evaluating Business Performance

The Importance of Accurately Calculating Deferred Revenue

Maximizing User Retention: How to Calculate Daily Active Users

Compounded Monthly Growth Rate: Understanding and Calculating Compounded Monthly Growth Rates

Calculating Your Company’s Total Addressable Market (TAM): A Step-by-Step Guide

Measuring Monthly Recurring Revenue: Expert Tips and Advice

Maximizing the Efficiency of Your Billing Process in Accounting

About the Author

Manjusha
Copywriter

Manjusha Karkera is an enthusiastic content marketer who has created numerous engaging and compelling writing pieces for various clients and companies over the years. She enjoys writing pithy content and copy on various sectors like fashion, beauty and wellness, sports, fitness, education, etc. Prior to Team upGrowth, she worked as a Marketing Communications Specialist. Her overall experience includes all forms of content writing and copywriting.

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