Customer Lifetime Value: Why It Matters and How to Calculate It

Ron Dodby Ron Dod

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Marketers are always talking about must-measure metrics for enhanced performance in business, advertising, social media effectiveness and similarly essential endeavors. 

However, one of the most important and least represented of these metrics is customer lifetime value (CLV or CLTV) and, quite often, retailers end up neglecting this figure altogether. This point is made clear by a 2018 study from Criteo, which found that only 34 percent of marketers were “completely aware of the term and its connotations.” Moreover, a paltry 24 percent felt that their brands were measuring customer lifetime value effectively. 

Those reading this post are likely in a similar boat. But that’s okay. By the end, we’re going to ensure that your brand falls into the effective 24 percent.

A good definition of customer lifetime value is the “prediction of the net profit attributed to the…future relationship with a customer.” This metric not only gives a company perspective to a customer’s long-term value, but it also serves as an indicator of how effectively a brand is in resonating with its audience and how much these folks like the company’s products. 

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When an uptick in customer lifetime value occurs, retailers can be sure that they are effectively engaging their customers. Therefore, once an increase takes place, merchants can use customer lifetime value as a measuring stick to reverse engineer the customer experience for subsequent buyers.

To get a real grasp on this metric’s importance and how retailers find it, here is everything retailers need to know about customer lifetime value.

Customer Lifetime Value: A Deep Dive

Customer lifetime value is a fundamental data point for understanding how valuable a relationship with a given consumer is for the business, and how well the organization is serving that individual.

By uncovering a customer’s lifetime value, retailers can establish the potential value to be generated from future marketing efforts. As is stated by analytics platform Custora

“Rather than thinking about how you can acquire a lot of customers and how cheaply you can do so, CLV helps you think about how to optimize your acquisition spending for maximum value rather than minimum cost.”

Therefore, effectively measuring customer lifetime value enables merchants to craft a strategy in which monetary investments yield far higher returns in the long-term.

Given that not all consumers are equal in how much they spend (their value), it is vital to understand which ones to focus on and invest in most heavily. This idea falls in line with the 80/20 rule, which dictates that 80 percent of a brand’s revenue will come from 20 percent of its customers.

Moreover, retaining customers is a far more cost-effective strategy than generating new ones. However, since few customers are loyal for life, it is best to view customer lifetime value as a periodic appraisal, typically falling into the 12-to-24-month period.

man reviewing finances on computers

The Necessity of Calculating Customer Lifetime Value

There are a variety of reasons for retailers to calculate CLV. One of the most significant is customer retention. The fact is that merchants typically stand a five to 20 percent chance of selling to prospects. On the other hand, those same retailers have a 60-70 percent chance of making a sale to an existing customer. Therefore, focusing on existing customers is far more likely to earn greater profits.

However, as mentioned earlier, there will be vast differences between a retailer’s customers. Some are far more valuable than others. By measuring customer lifetime value, sellers become more informed on how much they should invest in retaining current customers versus acquiring new ones.

Therefore, by calculating this figure effectively, merchants can work CLV into their marketing strategy as a means of better defining marketing goals and create better advertisements and sales strategies that keep acquisition costs low and retention high.

Moreover, since search engine marketing efforts tend to generate top-of-funnel sales with well-placed adverts and high-ranking content marketing achievements, retailers can sacrifice a campaign’s ROI to generate significant amounts of traffic that can then be reached after engaging with the brand.

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By employing retargeting and remarketing campaigns for previous site visitors, retailers can earn a new subset of customers. Once those individuals have made a purchase, not only are they more likely to make a second purchase, but a brand can continually engage such customers with personalized messaging to help boost their CLV.

What this strategy does is it helps to inform sellers on what types of content, ads and products that customers find appealing, while also providing signals on which devices they prefer.

When retailers can meet their audience with the products they need, the moment they need them and on the devices they use most, they become incredibly motivated to convert.

Without measuring customer lifetime value, merchants are reliant on profits from initial purchases to inform them on which customers are most valuable, and this isn’t terribly reliable data.

How to Calculate Customer Lifetime Value

Now that the necessity of properly calculating and integrating CLV has been made clear, it’s time to get down to the nitty-gritty.

There are a variety of ways to calculate CLV. Below are the simplest and most popular formulas that most organizations will have the resources to enact. However, it is important for sellers to make a choice and remain steadfast in its application.

customer lifetime value notebook doodle

Historical Customer Lifetime Value

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Historical CLV is simple, if not tedious, to calculate. This form of customer lifetime value is established by finding the sum of all gross profits made from a customer’s purchase history and dividing that number by the average gross margin.

This can also be done at the net profit level. Doing so will reveal the true profit for a given customer. However, doing so requires incorporating the cost of acquisition, returns, service and similar elements. This can result in some fairly complicated math. Therefore, it is likely best to stick with gross profit, unless resources permit a deeper dive.

However, there are some drawbacks to this method. Calculating CLV in this manner means that retailers must lump all of their customers together under the same umbrella, thereby eliminating the nuances of behaviors and preferences. This also doesn’t account for changes that have taken place within a brand, its offerings or its website. 

Predictive Customer Lifetime Value

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Predictive customer lifetime value is a more challenging model to work with as it seeks to paint a portrait of customer behaviors to successfully predict which actions they will take in the future. This method tends to be a much better indicator of customer lifetime value when compared to the historical model. However, it does require more time and resources to utilize.

Predictive CLV is driven by a customer’s transaction history and previous actions, using this information to forecast the value specific customers can generate.

Again, there are various ways to calculate this figure. For the sake of simplicity (and sanity) a more straightforward formula is:

customer lifetime value equation graphic

CLV = Average monthly transactions x Average order value x Average gross margin x Average customer lifespan (in months)

Aren’t you glad we’re keeping it simple?

Bear in mind that, much like historical CLV, the predictive model has its flaws as well. There is no foolproof method for calculating customer lifetime value. Predictive CLV is not always perfectly accurate. However, this does not mean that it is not extremely useful information to possess and put to work.

How to Apply Customer Lifetime Value

After calculating customer lifetime value, retailers can then utilize this data to refine and polish their strategies for brand loyalty, customer acquisition, sales forecasting and other essential aspects. 

Here are some of the ways in which retailers can apply CLV data.

Increase Loyalty and Retention

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Merchants can use customer lifetime value statistics to enhance customer satisfaction and retention rates. The more a brand knows about its customers and what engages them, the more effectively it can craft its programs and offers. By meeting customer needs and providing an enjoyable experience, retailers remain in a relationship with their audience for longer.

Moreover, this data allows for sellers to set their priorities and target the right customers to win back and woo over as the most profitable of the bunch have been established.

Enhance Forecasting

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drawing forecasting chart

By calculating customer lifetime value, eCommerce purveyors become more equipped to predict the future needs of the brand. This means that merchants gain a better understanding of how to manage future investments in inventory, manpower and similar assets. The ability to better predict such necessities is vital in minimizing productivity losses and enables business leaders to allocate resources appropriately.

Acquire Higher Value Customers

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After administering a CLV analysis of one’s customers, retailers should understand how much investment in customer acquisition efforts is warranted and at which point returns begin to diminish.

Moreover, merchants will have a sound grasp on the channels which are most effective for customer acquisition and which produce the most valuable customers. This information enables brands to create compelling strategies that encompass repeatable processes for generating new, high-value buyers.

Implement Value-Tiered Segmentation

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As mentioned previously, part of what makes calculating customer lifetime value such a beneficial and worthwhile endeavor is that the resulting information enables sellers to pinpoint which customers are the top-tier spenders, which are valuable but not the most profitable and which are the lower value customers.

When this identification and segmentation is complete, retailers can establish a firm grasp on which customers produce the bulk of their revenue.

From here, merchants can go about rewarding their most loyal customers to ensure that they remain engaged and delighted by the company’s offerings, while also developing strategies to encourage lower-tier customers to move up in the buyer’s hierarchy.

customer tier placement

Customer lifetime value is not an end-all, be-all to growth measurement metrics. However, it is a crucial one to understand, calculate and apply if an eCommerce business wishes to optimize their conversion rates and grow their brand.

The measurement of CLV helps retailers to better their customer acquisition strategies and deliver better brand interactions to all tiers of its audience by developing more engaging customer experiences. Moreover, this metric tells retailers if they are doing a good or bad job in the eyes of the consumer, which is the most crucial element of all.

We understand that some of the ideas and formulas behind customer lifetime value are a bit complex and intimidating. While this post covered the essentials, the rabbit hole goes much deeper.

If your brand wants to get down to the nitty-gritty of its CLV metrics, reach out to Visiture and we can help you obtain the insights that will help your brand grow by meaningful margins.

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