Selling to an existing customer is easier than acquiring a new one.
You do not want customers to churn before you are able to recoup the investment you made for them.
Measuring customer lifetime value (CLTV) is one of the best ways to mitigate this. Doing so will help your business acquire and retain highly valuable customers, which results in more revenue over time.
What is customer lifetime value (CLV)?
Throughout a customer relationship, customer lifetime value (CLV, or CLTV) represents the total revenue a business can expect from a single account.
This metric compares a customer's revenue value with the company's predicted customer lifespan.
Customer LTV is something that customer support and success teams can directly influence during the customer's journey.
The longer a customer continues to purchase from a company, the greater their lifetime value becomes.
Why is customer lifetime value important?
Customer lifetime value gives you the ability to leverage each customer's value throughout the buyer's journey. You can use CLV to increase customer loyalty, reduce churn, and make strategic business decisions to meet customer needs.
Customer lifetime value, for example, can be used to identify the most valuable customer segments.
Here are some other reasons why understanding your CLV is essential.
1. Increasing CLV can increase revenue over time
A business earns more revenue when a customer's lifecycle is longer or the customer adds more value during that lifecycle.
As a result, tracking and improving CLV leads to increased revenue.
CLV helps you identify the customers that generate the most revenue for your business. You can use this information to tailor your offerings to your highest spenders and keep them coming back for more.
2. It can help you identify issues so you can boost customer loyalty and retention
You can identify any worrying trends in your CLV by reviewing it as a priority in your business.
For example, if you find the CLV to be consistently low, you can work to optimize your customer support strategy or loyalty program to better meet the needs of your customers.
3. It helps you target your ideal customers
If you know a customer's lifetime value, you also know how much money they spend with your business over time - whether they spend $50, $500, or $5,000.
Armed with that knowledge, you can develop a customer acquisition strategy that targets customers who will spend the most at your business.
4. Increasing CLV can help reduce customer acquisition costs
Acquiring new customers can be costly. According to a recent article in The European Business Review, acquisition is typically five times more expensive than retention.
The most valuable customers that interact with your business must be identified and nurtured. By doing so, you'll have higher profit margins, increased customer lifetime values, and reduced customer acquisition costs.
Now that we understand the importance of customer lifetime value, let's talk about the two main customer lifetime value models.
Customer Lifetime Value Models
To measure customer lifetime value, companies will use two models.
Different outcomes can result from choosing between the two.
An organization may look at preexisting data, or determine the future behavior of customers based on current conditions.
Predictive Customer Lifetime Value
Using regression or machine learning, predictive CLV models predict the buying behavior of existing and new customers.
Using the predictive model for customer lifetime value helps you better identify your most valuable customers, the product or service that brings in the most sales, and how you can improve customer retention.
Historical Customer Lifetime Value
Based on past data, a historical model predicts a customer's value without considering whether the customer will remain with the company.
The historical model determines the value of your customers based on their average order value. You'll find this model to be especially useful if most of your customers only interact with your business over a certain period.
However, because most customer journeys are not identical, this model has certain drawbacks.
It is possible for active customers (considered valuable by the historical model) to become inactive and skew your data.
In contrast, inactive customers may begin to buy from you again, and you might overlook them because they've been marked "inactive."
Read on to learn about the different metrics needed to calculate customer lifetime value and why they're important.
Customer Lifetime Value Formula
Customer lifetime value is calculated by multiplying customer value by average customer lifespan. As a result, you can estimate the revenue that an average customer will generate for your business throughout their relationship.
How to Calculate Customer LTV
Value of a customer over their lifetime = (Value of the customer * Average Customer Lifespan). CLTV can be calculated by multiplying the average purchase value by the average number of purchases. Then, once you calculate the average customer lifespan, you can multiply that by customer value to determine customer lifetime value.
We'll look at both components of this formula (and how to calculate them) below.
Customer Lifetime Value = (Customer Value* x Average Customer Lifespan)
*Customer Value = (Average Purchase Value x Average Number of Purchases)
Customer Lifetime Value Metrics
There are many ways to calculate lifetime value, which is beneficial to businesses in many ways.
It helps businesses gauge financial viability and can improve customer retention with a data-driven understanding of what existing customers find valuable from your business.
As we examine the most common CLV formulas, analyze the variables that contribute to each to better serve your business needs.
Average Purchase Value
Divide your company's total revenue over a period (usually one year) by the number of purchases during that time period.
Average Purchase Frequency Rate
Divide the number of purchases by the number of unique customers who made purchases during that period to arrive at this number.
Customer Value
Calculate this number by multiplying the average purchase value by the average purchase frequency rate.
Average Customer Lifespan
Calculate this number by averaging the number of years a customer continues purchasing from your company.
Customer Lifetime Value Example
Using data from a Kissmetrics report, we can take Starbucks as an example for determining CLTV.
Its report measures the weekly purchasing habits of five customers, then averages their total values together.
By following the steps listed above, we can use this information to calculate the average lifetime value of a Starbucks customer.
1. Calculate the average purchase value
The first step is to measure the average purchase value.
According to Kissmetrics, the average Starbucks customer spends $5.90 per visit. We can calculate this by averaging the money spent by a customer in each visit during the week.
For example, if I went to Starbucks three times and spent nine dollars total, my average purchase value would be three dollars. We can repeat the process for the other five customers once we calculate the average purchase value for one customer.
Calculate the average purchase value by adding each average together, then dividing it by the number of customers surveyed (five).
2. Calculate the average purchase frequency rate
CLTV is calculated by measuring the average purchase frequency rate.
In the case of Starbucks, we need to know how many visits the average customer makes to one of its locations within a week.
The average observed across the five customers in the report was found to be 4.2 visits. This makes our average purchase frequency rate 4.2.
3. Calculate the average customer's value
By knowing how much the average customer spends and how often they visit in a week, we can calculate their customer value.
To do this, we have to look at all five customers individually and then multiply their average purchase value by their average purchase frequency rate. This lets us know how much revenue the customer is worth to Starbucks within a week.
Once we repeat this calculation for all five customers, we average their values to get the average customer's value of $24.30.
4. Calculate the average customer's lifetime span
Kissmetrics does not specify how it measures Starbucks' average customer lifetime span, but it does list it as 20 years.
If we were to calculate Starbucks' average customer lifespan, we would have to look at the number of years each customer frequented Starbucks. Then we could average the values together to get 20 years.
If you don't have 20 years to wait and verify that, one way to estimate customer lifespan is to divide 1 by your churn rate percentage.
5. Calculate YOUR customer's lifetime value
The CLTV can be calculated once we have determined the average customer value and the average customer lifespan.
In this case, we first need to multiply the average customer value by 52. Since we measured customers on their weekly habits, we need to multiply their customer value by 52 to reflect an annual average.
After that, multiply this number by the customer lifespan value (20) to get CLTV.
For Starbucks customers, that value turns out to be $25,272 (52 x 24.30 x 20= 25,272).
Tips to Increase Customer LTV
Now that you know your customer lifetime value, how do you increase it?
Here are some strategies that can help.
1. Optimize your onboarding process
Customer onboarding is the process of bringing your customers up to speed with your brand — what you do, why it matters, and why they should stick around. Onboarding happens in the first few days after customers make their first purchase.
When they head back to your website to look at other items or connect with you via email, they're learning how your company works and what you can offer.
The result? You need to stand out while making this straightforward.
Use the data customers have provided to offer curated item selections or great deals, and then follow up with email contacts to make sure what they've already bought lives up to expectations.
Why This Works
In addition to providing a framework for long-term customer relationships, optimized onboarding processes help increase CLV in the long run.
2. Increase your average order value
The best way to improve your CLV is to increase your average order value. When a customer is about to check out, you can offer relevant complementary products to those they're about to buy.
Brands like Amazon and McDonald's are examples of companies that use the upsell and cross-sell method extremely well. Amazon will offer you related products and bundle them into a group price as depicted below.
In contrast, McDonald's offers small add-ons - such as apple pies - that boost overall customer lifetime value.
Changing to an annual billing cycle can increase your average order and customer lifetime value if you're a subscription-based company.
Why This Works
CLV and overall revenue increase with even a small increase in order value over time.
Consider the example of the McDonald's apple pie. While adding a $1(ish) item to each transaction isn't much on its own, over time these smaller amounts add up to substantive revenue and help increase total CLV.
3. Build long-lasting relationships
Trust is the foundation of long-term customer relationships. When buyers believe your company offers the best prices on the products and services they want, they'll return. But this is just the beginning.
With social media now a critical part of any branding and marketing efforts, customers want more than just a business-based relationship.
Rather than simply a way to boost business ROI, they want to establish a personal connection. As a result, it's critical to engage with customers on your social media accounts with more than just canned advertising posts.
For example, you could do some social sleuthing to discover more about your customers and then send them a (small) free gift that aligns with their interests.
Why This Works
This works because you need to stand out from the crowd. Quick and easy eCommerce is now par for the course — if you can forge an actual connection with customers you'll keep them coming back and increase your total CLV.
4. Embrace good advice
Sometimes it's better to listen than talk.
When you listen to your customers, you can improve your business practices to better serve their needs and increase CLV. You could, for example, create a poll on new product or service ideas and ask your customers what they think.
Ensure that you don't lock them into a particular choice. Instead, give them room to add their own ideas that could help make things better. While not every customer will participate, those that do will often have good advice and can end up being some of your most loyal customers.
Quick tip: Give credit where credit is due. If a customer comes up with a good idea, credit them for the help and consider sending them something as a token of appreciation.
Why This Works
Your willingness to listen makes this work. You're showing that you're open to listening when you do this. Often, brands assume they know what customers want better than the customers themselves, which lowers total customer lifetime value.
By taking the time to listen and respond — even if customer advice isn't exactly what you want to hear — you can facilitate long-term loyalty and boost CLV.
5. Empower easy connections
You can't expect your customers to wait around for you to respond to their questions or connect with them. According to recent survey data, 88% of customers want emails answered within an hour.
While this isn't always possible, businesses can put practices in place to shorten response times and empower easy connections.
Active social media is one example. By equipping a customer success team with the tools and technology to monitor and respond to customer comments or concerns via social media, brands can jumpstart the connection process.
Why This Works
Relationships drive CLV now, and relationships require ongoing communication.
While one-hour email response times may be out of reach, the easier you make it for customers to connect with your brand the more connected they'll feel overall.
And the more likely they'll come back to spend more money.
6. Improve your customer service
90% of Americans say that customer service is one factor they consider when choosing companies to do business with.
Your customer service should be excellent if you want to increase your customer lifetime value. You can improve your customer service by offering existing customers personalized services, omni-channel customer support, and a proper return or refund policy.
Why This Works
The better your customer service, the more your brand is valued for more than just its products.
By standing behind your products with substantial return and refund policies, you communicate to customers that quality and satisfaction are your top priorities.
The result? Increased CLV.
The Benefit of Customer Lifetime Value
An incredibly useful metric is customer lifetime value. This tells you which customers spend the most money at your business and which ones remain loyal.
Start calculating CLTV for your business using the above formulas and model.