- Shows health of the company
- Measures value of average customer
- Normally asked by VCs and Shark Tank
Customer Lifetime Value is a metric used to measure the average customer’s value to the business over the customer’s lifetime. It is important because it is a marker of the health of a business. You are measuring how much an average customer spends, how often they buy, and how long they remain loyal to your company. Knowing Customer Lifetime Value (CLV) and its components are so important that it is often the core questions asked by venture capitalist companies and has gotten into popular culture that you can hear different variations of CLV in shows like Shark Tank. When you understand CLV, you will be able to improve forecasting for staffing or inventory and even be able to know which customers to target for marketing and sales campaigns.
How is CLV calculated?
- CLV = avg order value * avg purchase frequency (annually) * average customer lifespan (in years)
There are 3 main components to calculating CLV: average order value, average purchase frequency, and average customer lifespan. Average order value is how much the customer spends per order. Usually this includes cost so we can multiply this by the margin. For a bar, an ice cold Bud Light bottle is $7, but cost the bar $2, the average order value is $5. The average purchase frequency is how often the customer will buy from you in a year. This changes with each customer, but if we imagine a customer getting 2 beers every 2 weeks, that works out to 52 times a year. The average customer lifespan is how long the customer is expected to buy from the company. In the bar example we can use a year and 3 months as there’s always new bars popping up or sometimes customers move neighborhoods. Using the 3 components we find the CLV to be 52 x $5 x 1.25 = $325. The average customer is worth about 325 dollars to the bar.
If we compare a bar to a major coffee shop like Starbucks, we’ll see there is an advantage of scale where you have brand loyalty and customers come in more frequently. For simplicity, lets say the average customer gets coffee once every weekday for 20 years with the average price being $5. Since Starbucks can get lower prices due to economies of scale, the average cost for the coffee is $1. The CLV now becomes $4 (avg value) x 5 x 52 (frequency of purchase per year) x 20 (length of years as customer)= $20,800. We can see that raising any part of the components of CLV will affect the total lifetime value of the customer.
This type of calculation is easy and common for subscription businesses like Netflix. If the average customer spends $18 a month and they usually subscribe for 3.5 years, we get CLV of $756 ($18 x 12 x 3.5). It is a similar calculation to the above with the exception of cost. For simplicity’s sake we don’t add costs related to the customer such as data storage, etc.
The CLV can even help lower volume business such as car sales. Since we are not getting a car every year, we get what the annual number for would be. For a person that buys a car every 5 years, it would be .2 annually. For a person that buys a $50k car every 5 years for 15 years. We would get a CLV of $150,000. ($50,000 x .2 x 15).
Measuring CLV
- Track over time (longitudinal data)
- Customer Acquisition Cost (CAC) is the average cost getting a new customer
- Cost to Serve is average cost of keeping the customer
The first step after calculating CLV is to track how CLV changes over time. The frequency of tracking is usually annual, but looking at quarterly data shows trends faster and help look at effects of seasonality (ex. sales in spring year over year). Customer Acquisition Cost (CAC) is the average cost of getting a new customer. if a marketing campaign costs $5,000 and it will lead to 10 new customers our CAC is $500. This cost is then compared to the CLV and if the CAC is higher than CLV it does not make sense to pursue the campaign. The bar’s CLV is $325 and the marketing expense would not be worth, meanwhile it might sense for Starbucks, Netflix, and the car dealership since CAC is lower than CLV.
Cost to Serve is the average cost of maintaining the customer once they have already made a purchase. This differs from CAC in that cost to serve is an ongoing cost vs a one-time cost like a marketing campaign. If a client is new to a platform, they might have a lot of questions and would need a dedicated person to learn the process. This onboarding cost along with any other cost to keep a customer happy is included in the cost to serve. CLV is then compared to cost to serve to get a better view of the profitability of the average client. Since a customer only has onboarding costs at the beginning of the relationship, longer customer lifetimes would reduce this cost and will increase profitability.
CLV can also be used to segment customers. Once baseline CLV is established a business can start comparing customer segments to see who are high profit customers and what are high profit products. A shoe store needs to decide what type of customers to focus on for a marketing campaign. Would it be better to focus on new parents or 5k racers? A new parent is expected to buy their child shoes 7 times in 3 years at around $60 a shoe which has a CLV of $414 ($60 x 2.3 x 3). The 5k runner will buy 2 shoes every year at an average price of $130 dollars and will shop at your store for 4.5 years. The CLV of the runner is $1170 ($130 x 2 x 4.5). It would be better to focus on active runners vs new parents.
Improving CLV improves the bottom line
The easiest way to look at improvements would be how they impact each of the individual pieces of customer lifetime value. The main thing to remember is that we should focus on impact from the best customers and the best products.
Average price
- Upselling products
- Cross-selling products
- Increase Pricing
A simple way to raise the average price of a customer is to upsell either at checkout or getting current customers to have a higher value subscription. You can also cross sell products like Amazon when they suggest products that others buy when viewing an item. McDonalds does this when they ask if you would like fries with that shake. The simplest way to raise the average price portion of CLV is to simply raise the price. With all of these techniques the problem will be whether or not the approach will alienate customers and prevent them from their usual buying pattern. Using models to target the right customers with the right products will help and using A/B testing to make sure that we are testing and using the best approach on the smallest amount of clients.
Average number of transactions
- Simple buying experience
- UX/UI
- Cart abandonment rate
- Simple return policy
- Customer Engagement
- Provide omnichannel support
- Social Media
- Targeted Content
If scale was not an issue, a business prefers the customer to maximize a customer’s buying frequency. Customers will buy when it is easy and convenient to buy. Simply making a website easier to navigate and having items and commands at convenient or familiar locations is an approach that is tuned by using UX/UI. User experience and user interface teams finds the most appealing way to present a website or app to make buying and navigating intuitive. At the same time, you can use analytics to help nudge clients to buy by reminding them that they left items in their cart. This practice is part of mapping customer journey which is helpful for businesses to ensure they are getting the best value from their customers. Part of the customer experience is making sure the customer is engaged with the company or product
Retention
- Maintain and exceed quality
- Customer Loyalty
- Rewards Programs
- Customer Experience
- Improve Customer Onboarding
- Improved Customer Service
- Customer Feedback Loop
- For bad customers
- Invest in Technology & Software
Keeping current customers happy is the easiest way to keep their business coming. Loyalty programs encourage repeat business by offering discounts or benefits that come after a certain amount of purchases. A customer rewards program targets the highest CLV customers with offers on products that they enjoy or products that they might enjoy in the future. A little personalization goes a long way for retention. The effectiveness of these programs provide are examples of why a customer experience plan must be place.
Customer journey mapping is designed to learn the customer’s process to find which steps can be made easier and to find potential bottlenecks to better customer service. Knowing where pain points and attrition points occur will help the business figure out what customers are likely to drop out of the customer journey (stop using the business / stopping the subscription) and help find ways to make them happier for longer. There are a lot of companies that provide this service can be found using a quick search for customer relationship manager in your industry. Make sure to choose CRM providers that focus on customer experience, show customer journey mapping, and other technologies such as cart abandonment.