What is Customer Lifetime Value (CLV) and Why Does it Matter
Did you know that companies with an engaged customer base can expect about 80% of sales to come from 20% of their customers? That’s why, it is vital for brands to be able to identify their most loyal shoppers and invest wisely in increasing their Customer Lifetime Value (CLV) rather than spending away their valuable advertising budget.
Let’s dig right in with a rather over-simplified example of CLV.
Let’s assume that you’ve spent $1,000 on acquiring new customers (this can be the money spent on marketing budget, ads, etc.) and managed to get 5 new customers. This makes the Customer Acquisition Cost (CAC) per customer $200.
Now, one of your customers—Amy—spends around $250 every year, and continues to do so for the next 4 years. The CLV of Amy is $1,000. But, you also spent $200 to acquire her as a customer. So, your CLV for Amy totals to ($1,000 – $200) $800.
Even though it may seem like simple math from the example above, calculating and optimizing Customer Lifetime Value is a crucial measure for business success.
CLV is the total value generated by a customer for the business, over the total lifetime of the customer-business relationship.
This is one of the top metrics and a key KPI for every business as it focuses not only on the revenue generated by a customer at a single point in time, but also the compound value of the customer over a period of time. And the longer a business is able to retain a customer, the higher will be the CLV.
Knowing the true numbers behind the CLV helps businesses develop effective strategies in acquiring new customers and retaining existing ones, while keeping an eye out for profit margins.
How to Calculate CLV
To calculate Customer Lifetime Value, you need to first calculate the average purchase value, and then multiply it by the average purchase frequency rate.
In order to fully understand how CLV works, let’s break it down into Lifetime value (LTV) and CLV.
Now, LTV is the total revenue generated by a customer over the entire period of their interaction with the company:
Lifetime Value = Average Value of Sale × Number of Transactions × Retention Time Period
It is important to note that the Lifetime Value is calculated in terms of the revenue generated by the customer and does not take into account the costs involved in acquiring the customer, nor the profit margins.
Which is why we need to refine the formula to arrive at the Customer Lifetime Value:
Customer Lifetime Value = (Lifetime Value × Profit Margin) – cost of acquisition
However, depending on the nature of the business, the dynamics of customer interactions, and many other variables, the methods used to calculate Customer Lifetime Value may vary. For example; the calculation of Customer Lifetime Value for an automobile brand and an eCommerce retailer may be entirely different.
Most industry experts agree on certain parameters that can effectively help measure the CLV for a business:
- Identifying touchpoints where customers start to create value
- Monitoring customer activity across channels, devices and time
- Measuring revenue potential at each point
- Potential for re-engagement
Businesses that can successfully identify and monitor all the above points will have a greater chance of improving CLV.
The Real Deal With CLV
Understanding the CLV is important to a business because it helps track a success metric with a data-driven approach. But leaving the complex calculations aside, CLV comes down to building and maintaining a long-term relationship with your customers.
Tracking your CLV also means that you are able to understand and optimize the customer experience and be mindful of customer feedback along all the key touchpoints. All of which will eventually help improve more than just your revenue.
As one of the key metrics for business success, CLV is also a key indicator of attrition and plays a vital role in curbing attrition rates.
What’s the Difference Between CLV and Customer Retention?
In more ways than one, customer retention is a key element of Customer Lifetime Value. The longer you are able to retain a customer, the greater the Lifetime Value of that customer. Customer satisfaction and customer retention are two great ways to increase your Customer Lifetime Value.
In fact, according to a study by Harvard Business Review, a mere 5% increase in customer retention rates can boost profits anywhere from 25% to 95%.
Many businesses often focus on achieving an immediate sale. While this may prove successful in the near term, this approach is short-sighted as it overlooks the compounded and long-run benefits from Customer Lifetime Value. While it is important to find new customers in order to grow, optimizing Lifetime Value is crucial to create and sustain a viable business strategy.
So, the answer is yes and no: because Customer Lifetime Value does require a robust customer retention strategy. Simply put, we can say that customer retention is one of the pillars of Customer Lifetime Value.
Looking at CLV in the Light of Cost of Acquisition
CLV is a great metric to have—it tracks growth over time. But is CLV self-sufficient? One must not forget that businesses also incur certain costs to acquire customers, retain them, and serve them in a satisfactory way. So it becomes imperative that CLV is analyzed along with the Cost of Customer Acquisition (CAC).
It is a delicate balancing act. The initial Cost of Acquisition to Lifetime Value will be higher (LTV : CAC ratio) but as customers stay longer with you, the costs drop off.
Many companies turn their focus to customer acquisition and spend large sums of money in acquiring new customers. While this will reap benefits in the short-term, the cost to value ratio is high, and it means your profitability margin is reduced.
Acquiring new customers can cost up to 5 to 10% more than selling to existing customers. And on average, existing customers spend 67% more than new customers.
If the revenue for a business is directly related to the sales and marketing spends, then it becomes vital to optimize these expenses and improve customer retention in order to truly boost your Customer Lifetime Value. The question that all business owners must ask is how scalable is the marketing strategy? Most often companies invest heavily into marketing and sales enablement, which translates into high costs. But if your revenues are not increasing significantly, the profit margins will be thinned out and revenues will no longer be satisfactory.
How Can Businesses Optimize Their CLV?
The most common mistake that businesses make is viewing CLV as a stand-alone metric. It’s vital to remember that CLV is an umbrella term that comprises acquisition, engagement, conversion, and retention strategies.
In today’s mobile-first world, engagement is at the heart of customer expectations and brand engagement. As businesses are looking to improve their digital growth, customers are expecting new and meaningful ways to engage with brands. Below are some basic strategies that marketers need to adopt in order to optimize their CLV:
Keeping the Churn Rate Under Control
The highest probability for a customer churn comes right after the initial engagement/purchase by the customer. The possibility for new customers to churn is higher during the initial days of their interaction with a brand.
This is where businesses need to come up with effective and engaging onboarding strategies. It is not a pushy step where the new customer is flooded with emails and/or push notifications, rather it is a compassionate step where the business pays attention to the needs of a new user and understands how to positively impact their experience.
Keep the Communication Open to Improve Customer Experience
New customers will often have more questions during the initial days of their interaction with a business, and being able to reach out with questions and concerns is vital for customers. Which is why businesses need to ensure that communication channels are open and available to address any concerns that users may have.
Additionally, effective communication between a brand and customers will strengthen the relationship and humanize the brand in the eyes of the customers. Keep in mind that like many people in life, your customers too seek acknowledgment and desire to be heard.
A recent report by Walker Study points out that 86% of buyers are willing to pay more for better customer experience. According to New Voice Media, only 1% of customers feel that their needs are always met, and this dissatisfaction results in an annual opportunity loss of $41 billion for companies in the US.
This presents marketers with a unique opportunity and urgency to step up their customer experience game.
Retarget Customers & Don’t Focus Only on Acquisition
One of the most effective ways to improve CLV is to re-engage users who have previously interacted with a brand. In addition to increasing brand recognition, retargeting also works by strengthening previous experiences, by motivating the customer to fall back on the same brand every time they need to purchase something similar.
CLV — A Must-Have Strategy
Customer Lifetime Value holds more promise than you think. It impacts customer retention rates and is also an expression of the personalization on offer.
If CLV has not been an action item on your list, now is the time to include it. It is imperative that businesses focus on retaining customers just as much as they invest in acquiring new ones, if not more. The more effort you put into optimizing your CLV, the more revenue your customers will bring.
Globally the average value of a lost customer is $243 and the probability of selling to an existing customer is 60 – 70%; while the odds of selling to a new customer are only 5 – 20%.
But, it is more than just a fatter balance sheet—CLV is the heart of brand-customer engagement. It shows the level of personalization invested by a company into delivering unique and relevant customer experience across all touchpoints. As personalization is at the heart of engagement today — 94% of businesses believe that personalization is key to future success — Customer Lifetime Value becomes a long-term goal, one with great potential to beef up your profit margins and reduce acquisition costs.
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