The Importance of Customer Lifetime Value (CLV) and How to Calculate It

by Mary Cole

Last updated on December 3rd, 2018

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The metric customer lifetime value (CLV) might not sound very important, but failing to calculate it can put you behind your competitors.

CLV tells you how well you’re resonating with your audience, how much your customers like your products or services, and what you’re doing right — as well as how you can improve.

What business owner or marketer doesn’t want to know that information?

Math isn’t everyone’s strong suit, but learning how to calculate customer lifetime value doesn’t require high-level arithmetic.

Furthermore, you can continue to calculate this metric over and over again to establish map points as your business grows.

When your customer lifetime value increases, you know you’re making a better impression on your existing customers. You can then reverse-engineer the experience for future customers.

But first, what is customer lifetime value? And how can you increase it for your business?

What is Customer Lifetime Value (CLV)?

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Customer lifetime value is the average amount of money your customers will spend on your business over the entire life of your relationship.

For instance, if a customer continues to buy products or services from your business for 10 years and spends $10 per year, his or her customer lifetime value is $100, minus any money you spent to acquire that customer.

Imagine that you sell socks from an e-commerce store.

You spend $5 in advertising to attract a customer. He or she buys an average of seven pairs of socks every year for 10 years. Your profit margin on each pair of socks is $10.

Based on this data, you profit $70 per year from the customer, which works out to $700 over the decade. You then subscribe the amount of money you spent to acquire the customer, which results in a net customer lifetime value of $695.

That’s a simplistic example, of course, but it demonstrates important data.

The Importance of Customer Lifetime Value

Your customers aren’t just worth the amount of money they spend on your business today. They have future value if you’re able to retain them as customers.

In the example above, we took advertising into account. It cost us $5 to attract one customer who wound up spending more than $700 in our fictional e-commerce store.

But what if we sold those 70 pairs of socks to 70 different customers?

We’d have to spend $5 per customer to acquire them, which would reduce our profits considerably. Plus, our brand loyalty would take a huge hit.

Customer lifetime value is important because, the higher the number, the greater the profits. You’ll always have to spend money to acquire new customers and to retain existing ones, but the former costs five times as much.

When you know your customer lifetime value, you can improve it. Work on retaining your existing customers through email marketing, SMS marketing, social media marketing, and more. You still want new customers, but don’t forget about the old ones.

How to Calculate Customer Lifetime Value

Several different methods exist to calculate CLV. The customer lifetime value can be either historic or predictive.

In other words, you might want to calculate CLV based on actual purchases over the years or based on what you predict customers will spend.

Regardless, you need to know the average profit margin for purchases, the amount you spend to acquire a customer — customer acquisition cost — and the length of your relationship with customers.

The way you calculate customer lifetime value can also vary based on your business model. For instance, it’s easier to calculate CLV if you have a subscription model than if you’re in e-commerce. That’s because sales become more predictive.

Companies like BarkBox and ButcherBox charge the same amount every month for their deliveries, and their customers pay monthly or annually. It’s harder to predict how often a customer will return to buy new socks from your online retail storefront.

Customer Lifetime Value Formula

The simplest customer lifetime value formula is the historic model. The CLV is equal to the total value of each transaction multiplied by your average gross margin.

Let’s say a customer visits your website 10 times and spends $10 each time.

Your average gross margin is $5 after taking into account how much you spend to get the average customer to spend money, which means you’ll multiply $100 (the total amount spent) by $5 (your average gross margin) to get $500.

If you want to take the predictive approach, you’ll need to get a little more complex.

This customer lifetime value formula requires several data points:

  • Average monthly transactions
  • Average amount spent per transaction
  • Average number of months your customers remain loyal
  • Average gross margin

Multiplying these numbers together will give you the predictive CLV.

9 Ways to Increase Your Customer Lifetime Value

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Now that you know how to calculate CLV, how do you improve it? Follow these nine tips to boost your customer lifetime value and retain more of your customers.

1. Segment Your Email and SMS Lists

Whether you’re marketing to your customers via email or SMS — or both — make sure they get segmented based on where they are in the sales funnel and what their interests are.

Someone who’s interested in your activewear line won’t want the same content as someone who wants to buy your dress socks.

Similarly, if a customer has only recently been introduced to your brand through an educational blog post, he or she probably isn’t ready to buy.

He or she doesn’t need the same content or messaging as someone who has demonstrated intent to purchase.

You also need a segment for repeat customers. You’ll want to keep in touch with those people and bring them back to your site for future purchases.

Too many marketers focus on bringing in new customers and forget about those who have already spent money on their businesses.

Once you’ve segmented, you can use drip campaigns to nurture both prospective and existing customers. Don’t bombard them with salesy messages. Instead, build relationships with them.

2. Build Products or Service That Complement Existing Offerings

The number of products or services you sell will depend on several factors, including whether or not the customer is likely to quickly buy more of what you have.

For instance, someone who sells socks will sell more products that someone who sells washing machines. People need new socks more often than they need new washers.

However, you can build products or services that complement your existing lineup to encourage more purchases.

For instance, maybe you sell washing machines as well as your own brand of detergent. Customers who buy your machine might also want the detergent made specifically for it, and might therefore become recurring customers.

Alternatively, maybe you sell one great product that people buy over and over again. Instead of creating something else to sell, focus on recommending your product as a potential gift idea.

3. Take Advantage of the Freemium Model

One of the best examples of the freemium model increasing customer lifetime value is in-app purchases. You can play Candy Crush without spending a dime, but if you want to purchase extra lives or other boosts to the game, you need to pull out your wallet.

This model increases customer lifetime value because customers get to try out your product, become enamored of it, and decide to spend money.

In just one year, Candy Crush managed to rake in nearly $1 billion. That’s pretty impressive for a company that makes games people can play for free.

If your business doesn’t lend itself to the freemium model, you could offer different levels of flexibility and features. For instance, you might manufacture three different blenders that increase in efficiency and price point. That way, your customers not only have more choices, but they can upgrade to the better model, thus spending more money.

4. Consistently Send Out Coupon Codes and Other Special Offers

Coupon codes are vastly underrated. People love getting a deal, and even if your 10-percent-off coupon still leaves you a healthy profit margin, consumers will take advantage of it.

The question is when to send out your coupon codes or other special offers.

If you’re interested in increasing customer lifetime value, consider sending a coupon code a couple weeks after a customer makes a purchase.

The transaction is still fresh in the customer’s mind, so he or she will be more willing to return to your site and check out other products or services.

Try offering a discount on the purchase of two or more items. You’re encouraging the customer to spend more money, but it still feels like a deal. Product and service packages work well for a reason. If you can save money by bundling your Internet, television, and phone service, why wouldn’t you?

5. Make Use of Thank-You Emails

Gratitude goes a long way in business. It’s also a great way to keep in touch with your customers.

A thank-you email is a message you send customers right after they purchase something from you. It doesn’t ask for anything — it just lets the customer know you appreciate their patronage. And, as a free gift, you might include a coupon code to boot.

The point is to make contact with the customer right away. Keep your brand top-of-mind to encourage repeat visits to your website — and, with any luck, repeat purchases.

Thank-you emails can also be the starting point for a new drip campaign. A few days after the thank-you email, you might send a quick survey to ask about the customer’s opinion of the transaction. This constant contact can increase customer lifetime value exponentially.

6. Funnel Traffic From Social

If someone buys from you, they might also follow you on social at the same time. Don’t squander that opportunity.

Keep in touch with your regular customers via social and target them with offers to come back to your site, such as to a landing page. Send out lots of gratitude when people buy your products and services so they know how much you appreciate them.

At one time, your online presence might have existed solely on your website. That’s not true any longer. You’ll want to take advantage of all contact with current and prospective customers to keep the traffic flowing from one online presence to another.

You’ll increase brand awareness, which can have a direct impact on customer lifetime value.

7. Create a Seamless Buying Experience

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People often fail to purchase products from a company more than once because of problems with the buying experience.

Customers get irritated if they’re timed out during the purchase process or if you ask for too much information.

Conversely, customers who enjoy a seamless buying experience often share that fact with their friends. They let others know that you not only sell a great product or service, but that it’s easy to buy from you.

Consider offering more payment options, reducing form fields, and estimating shipping costs from the beginning. Don’t put any roadblocks in the way that might discourage first-time buyers or cause existing customers to boycott your business for good.

8. Use Checking-In Emails

Another great way to boost customer lifetime value is to get in touch with dormant customers.

These are people who have bought from you in the past, but have been inactive for a long period of time, such as six months.

Send an email that casually asks how they are and whether they’re interested in returning to your site. You can also give them the option to opt out of your emails if they’re no longer interested.

This might seem like a bad thing, but scrubbing your email list of dormant or inactive subscribers can have a positive impact on your business.

If people aren’t interested in hearing from you, don’t give them a reason to send your emails to spam.

Those who do still want to hear from you might remember how much they liked your products and services and return. That will increase your customer lifetime value.

9. Offer a Loyalty Program

Want your customer lifetime value to shoot through the roof? Start a loyalty program. Customers can earn points toward future purchases and save money at a later date.

There’s a reason so many brick-and-mortar stores, from Walgreens to Best Buy, have loyalty programs. They work. Even if you’re online-only, give your customers the chance to save money on a future purchase by continuing to buy from you.

Conclusion

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Customer lifetime value matters more than you think. It impacts customer retention rates, reveals the level of brand loyalty you command, and helps your business stay in the black.

If you’re not actively trying to improve CLV, now’s the time to start.

Focus on retaining customers as much as you work to acquire them in the first place. Use Crazy Egg’s heatmap tools to figure out where people are clicking, how far they scroll down your sales pages, and more so you can optimize your site for the optimal shopping experience.

The more effort you put into customer lifetime value, the more revenue your business will generate.

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Mary Cole

Mary is a self-acknowledged numbers nerd who loves using analytics to drive business decisions. She currently consults for a handful of B2B/SaaS startups out of her home office in Austin.

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