LTV or Customer Lifetime Value is a crucial metric that determines the profitability of your business. In this page, we’ll explore how to calculate and optimize your LTV, and the strategies you can use to increase customer retention and revenue. Let’s dive in!
What is Customer Lifetime Value (CLV)?
Customer Lifetime Value is the amount of income a brand generates from a customer after acquiring them over the time they interact with your brand.
CLV is not limited to a single purchase, as brands usually acquire future sales from their customers. Several KPIs are out there to measure the CLV. Still, it heavily relies on two critical factors. The prime denominators are the total time for which the customer is retained and how often the customer makes purchases. As cited by BusinessWire, the customer acquisition cost (CAC) has increased by 60% since 2017. As CAC shows steady growth, businesses are acquiring lower profits, which places more importance on CLV.
Calculating Customer Lifetime Value
One can calculate the customer lifetime value by multiplying the total purchase value made by the customer with the retention time and the number of transactions.
CLV Formula: Average Value of Sale X Number of Purchases X Time Retained X Profit Margin of the Business.
For example, on average, the total sale of an e-commerce brand is $50, and the customers make a purchase thrice a year. The lifetime value of an average customer will then be $300, based on a two-year estimation, $50 X 3 (number of purchases in a year) X 2 (Timespan). Considering a profit margin of 20% for the brand in the example, the average CLV will amount to $60.
1. Accumulated data method
The accumulated data method falls amongst the most accurate lifetime value models. The customer lifetime value is calculated based on the historical data of a customer’s purchases. In such a case, the brand generates the information through different sales processes.
The accumulated data method allows a business to identify the CLV of a single customer.
CLV formula using accumulated data method: Order 1 + Order 2 + Order 3 +….Order n, where n stands for total orders made by a customer.
2. Average estimate method
As the name suggests, the average customer lifetime value model is an important KPI for determining revenue. This process estimates the possible CLV of a customer based on the average CLV acquired by a business over time. The accuracy of this estimate depends on the amount of available data. For example, a company with 10,000 retained customers will have a better estimate than a business with 1,000.
Estimated CLV Formula: AOV X AN, where AOV stands for average order value and AN stands for the average number of orders a business receives after a customer is retained.
Why is CLV so important?
As underlined by BusinessWire, the cost of customer acquisition (CAC) has increased by 60% since 2017. It means a business must spend more budget to acquire a single customer. Certain factors, like the number of competitors in the industry heavily, dictate the CAC.
Such predictions also indicate an unprecedented increase in CAC, thus denoting more marketing spending for acquiring a single customer.
1. Increasing CLV can increase revenue over time
Focusing on the research done by Bain and Company, an increase in the customer retention rate of 5% has been shown to increase a company’s profit margins from 25% to 95%. It proves that the cost of retaining a customer is a fraction of what CAC amounts.
A business with more retained customers will likely have a higher profit margin and more revenue over time. For example, if a company has 10,000 retained customers with an average customer value of $300. One can expect a total income of $30,000 from the mentioned number of customers.
The estimated total revenue heavily depends on the number of retained customers and the average lifetime value of a customer. Therefore, the more customers a business has, its chances of increasing revenue over time rise.
2. It can help you spot issues and boost customer loyalty and retention
Unbiased reviews on the products and after-sales support are the best KPIs for any company. As customer retention plays a massive role in increasing profit margin, the importance of the mentioned factors is unfathomable. For example if your CLV is low, you can work on optimizing customer support and meet the needs of customers.
Reviewing these two services can always help a company understand common issues. Once such problems are identified and fixed, a brand can expect a better customer retention rate. Furthermore, customers tend to acquire a sense of importance when considering their opinions.
3. It helps you target your ideal customers
Data-driven decisions within a company are 23 times more likely to acquire a customer in a competitive market status report published by Mckinsey Global Institute. As per leading experts, the best way to create the perfect customer profile is to use data from existing customers. Zeroing down on the most common traits of all the current customers can allow a business to create its ideal customer profile. Once such a profile is made, with the complex targeting features provided by advertising platforms like Google, one can quickly bring down the CAC.
4. Enhancing CLV can help cut customer acquisition costs
The upfront cost of acquiring a customer dictates a company’s profit margins. As per the statistics above, the CAC is at an all-time high with a prediction of future growth. It might be somewhat daunting as the profit margin will further decrease.
The most feasible solution to such a problem is increasing the CLV of a customer. The cost of retaining a customer is negligible when compared to CAC. A company can acquire a higher profit margin from the second sale onward. The average profit margin increases when such a process is repeated over a brief period.
Customer Lifetime Value Formulas
A company can use several KPIs to create a detailed analysis of its retained customers. Some of those KPIs are Average Purchase Value (APV), Average Purchase Value Frequency, Customer Value, and Average Customer Lifespan. The formulas for the mentioned KPIs are provided below.
Average Purchase Value
Average purchase value is computed by dividing the total business acquired (TRC) by a customer by the number of purchases (NP).
The formula for Average Purchase Value: TRC/ NP
Average Purchase Frequency Rate
The Average purchase frequency rate is deduced by dividing the total number of purchases (TNP) by the total number of unique customers (UC).
The formula for Average Frequency Rate: TNP/UC X 100
The Customer value is computed by multiplying the average purchase value (APV) by the average number of purchases (ANP).
The formula for Customer Value: APV X ANP
Average Customer Lifespan
Average customer lifespan, or the ACL, is calculated by dividing the customers’ lifespan by the number of unique customers.
The formula for Average Customer Lifespan: Sum of Customer Lifespan/ Number of Unique Customers.
How to Increase Your Customer Lifetime Value
1. Start a loyalty program
Loyalty programs are considered one of the best ways to increase customer lifetime value . As mentioned by a study done by Harvard, the leaders of loyalty programs in the industry have grown their revenue 2.5 times faster than their competitors. Consumers tend to stick around with a brand that offers a loyalty program, thus increasing their spending limit.
You can use different perks like reward points, gift cards, discounts and others to offer loyalty programs to your customers.
2. Invest in customer experience
A good customer experience has a significant influence on the retention rate in a company. From a survey done by Forbes, 74% of consumers expressed their views of sticking with a brand that provides a good customer experience.
You can provide a good customer experience through these simple ways:
- Being open to customer feedback
- Removing slow customer support
- Offering faster and easy support
- Showing gratitude toward consumers
- Preparing great unboxing experience
3. Offer easy returns
The lack of a transparent return policy diminishes a brand name, leading to customers leaving. Providing easy returns might allow a business to show its commitment to the customers. It sends a positive message and is usually followed up by recurring purchases.
4. Upsell and cross-sell
Upselling is a market strategy to make customers buy premium versions of a purchased item. These are usually expensive products which are used to make larger sales. Upselling works to increase CLV by selling it to existing customers and increasing average order value. On the other hand, cross-selling is persuading customers to purchase products in addition to the original items they intend to buy.
Upsells and cross-sells constitute more than half the revenue generated through customer retention. The easiest way to identify an upsell or cross-sell is to understand the follow-up problem created by the product sold. Once a solution to the follow-up problem is given, the chances of a sale are likely to go up.
5. Provide amazing customer service
Customer service is the bread and butter of a reasonable retention rate. With 77% of consumers stating that fantastic customer service is as essential as the quality of the product, Forbes clarifies the need for exceptional customer service.
Companies can improve asking customer feedback on what channels they prefer for support. They can opt from self-service, social media or website live chat. Once you have a clear idea, you can invest in the same and provide better support.
6. Use email marketing
Email marketing is currently the cheapest marketing channel providing a considerable investment return. As Statista emphasizes, companies that consistently use email marketing have witnessed a return of $36, against an investment of $1. As a tested model, there is no doubt regarding the efficacy of email marketing.
7. Be active on social media
Follow-ups and engagement are two sides of a coin that serves as a reminder and keeps a customer updated. As most audiences are active on social media, a brand can leverage this by being active and engaging the fans.
8. Start a subscription service
Subscription services almost guarantee a monthly revenue for any company. With proper customer support in place, a good subscription service has allowed a business to grow 5-8X faster than its competitors, per an SEI Report. It can also be considered an automated customer retention program since no cost of retention or additional effort is required.
How You Should Look at Customer Lifetime Value on E-commerce Stores
The current digital landscape provides data in every aspect of the processes encompassed in customer acquisition. The proven way is to divide the overall digital space into smaller categories and compare the cost of acquiring versus the revenue earned. Some of the common categories on how one can look at CLV have been mentioned below.
Customers tend to gather on different platforms based on their interests and convenience. There might be some customers who read their emails, but there will be others who never open them. Similarly, some customers are hyper-active on Meta, while others might prefer Youtube.
As a company accumulates customers, it can try to decipher the channels with most of its ideal customers. It helps bring down the CAC, and the cost of retention, as these customers are more likely to see the offers posted by a business.
Location is a common grouping category used by many businesses. Global exposure is a perk, but advertising in every location requires a massive budget. Once a company accumulates a substantial number of customers, they create segments based on the location of these customers. When a company identifies a prime location where getting sales is more straightforward, both CAC and cost of retention decrease.
A business can divide its products into different categories and judge their profitability based on the sale acquired from each category. It allows a company to understand the likeability of the product and improve certain ones, if necessary. One can use proven strategies such as upselling and cross-sell from this insight.
Every brand is defined by a set number of features in the general audience. One can always ensure that exceptional customer service and other customer-favorite strategies, such as easy returns, are always related to the brand. Constantly improving the mentioned services and taking customer feedback can help one achieve such a feat.
Analyzing a set of customer responses, also called a cohort, is a good practice. A business can enforce a monthly cohort to understand its customers better.
Any business can divide its customers into several segments. Segmentation is done by selecting one or more common traits specific customers exhibit. This allows a company to create laser-focused offers specific only to a particular segment. Dividing customers based on common pain points is a perfect option that has been shown to work well in many industries.