CLTV: What is it Customer Lifetime Value and how do we calculate it?
4min read - iAdvize
Businesses focus more on customer acquisition than customer retention and according to Kissmetrics they do so even though acquisition can cost 7x more! Businesses should focus on building a customer retention strategy and invest in the online customer experience. The key metric that organizations need to monitor when it comes to customer retention is the customer lifetime value. In this article, you will find out what it is, how to calculate it and why it is so important for your business.
It is about time to invest in relationships with the customer and Forrester predicts that 3 billion dollars of interruptive advertising budget will be reassigned next year to a conversational experience.”
Julien Hervouët - CEO of iAdvize
What is the Customer Lifetime Value?
The customer lifetime value is a prediction of the total net profit your business makes from the future relationship you will have with a customer.
You can estimate the value of your future relationship with a customer in many different ways: the level of accuracy or the level of your formula’s complexity can vary from one company to the other. One key factor of the customer lifetime value is customer segmentation. You need to understand that all your customers don’t have the same importance for your business.
Why is the Customer Lifetime Value important for your business?
It is a metric that helps you decide how much you are willing to spend to reach and get customers for your business.
A tool for Contextual Marketing
Calculating this metric gives you an idea of how much repeat business you can expect from your customers. As customer lifetime value uses customer segmentation, it allows you to determine which groups of customers are the most profitable for your business, understand their behaviors, get to know them. And by getting to know them, you know how to make them happy which allows you to personalize your relationship with them and retain them by giving them solutions according to their context.
A key metric with different interpretations and purposes
Your customer lifetime value affects different important services within your business: the marketing, product, customer support and sales department. These departments have all different goals but they are all related to your customer lifetime value:
Product team: How can I make sure the products I offer to my customers are personalized? How can I make sure they meet their needs and expectations?
Customer support: How can I retain customers? How much should I spend to retain customers? When does it become too expensive?
Marketing team: How can I acquire new customers? How much should I spend to acquire new customers? When does it become too expensive?
Sales team: Which groups of customers should sales representatives target? Which groups of customers are the most valuable to acquire for my business?
It takes 12 positive experiences to make up for one unresolved negative customer service experience.
Ruby Newell Legner - Understanding Customers
Long story short, the aim of the customer lifetime value metric is to assess the value of your customers over time. And if you know what customers are worth, you know what you should spend to get them or what you should spend to keep them.
How can you calculate your Customer Lifetime Value?
Before starting to calculate your customer lifetime value you need to know two important metrics: the average order value* and the repeat purchase rate.
Then, it can be fairly simple to calculate the customer lifetime value. First, you need to calculate your customer retention rate**. i.e. if 80 out of 100 of your customers remained your customers from last year to this year, you have a retention rate of 80%.
Now, here is the most simple formula to calculate your customer lifetime:
Customer lifetime = 1/(1-Retention Rate)
If we come back to our previous example with a 80% retention rate, your customer lifetime equals 1/(1-0.80) = 5. You have a 5 year customer lifetime.
It might seem very simple to calculate your customer lifetime, but in fact, to calculate your customer lifetime value, there are a lot of other factors to take into consideration that will complicate the formula:
- Time-bound contracts
- Discounts conceded to your customers
- Contribution margin
- Retention cost
- Specific periods: we generally calculate the retention rate over a year, but according to your sector you might need to calculate your customer lifetime value on other periods of time.
Customer lifetime value can also be calculated over specific time periods but it can also be predictive.
If you want a really good way to calculate your customer lifetime value, I suggest you visit CleverTap's website. They explain how to calculate, estimate and predict your customer lifetime value. And to do so, they explain that you need to “take the revenue you earn from a customer and subtract out the money spend on acquiring and serving them”.
How can you improve your customer lifetime value?
Monitoring the customer lifetime value is already a sign of improvement for your customer service and the customer experience you provide: you recognize that your customers are important and you try to understand their behaviors to enhance your relationship with them.
The importance of being there when customers need you
Between social media, your website and messaging apps, your customers can use countless touch points to reach you. Make sure you are available to help them when they need your help. Help them get past their confusion, help them find a solution to their problem.
70% of buying experiences are based on how the customer feels they are being treated.
Customer service is today’s marketing
The customer journey is a never ending circle and great customer service is a common denominator of truly successful businesses. Building a trusting relationship with your customers is far more valuable than any one-time exchanges you might have with them. You will acquire new customers by showing that you are great at retaining the ones you already have.
The customer lifetime value is not a static concept, it may change according to different parameters. Let’s say your retention rate lowers or increases, you will need to recalculate your customer lifetime value for each group of customers you have. It is very important for you to constantly be attentive to your customers’ needs and expectations. Be there when and where they need you. Hear what they have to say. Personalize your interactions with them. Understand their context. And you will improve your customer lifetime value in the long run.
*the average amount customers spend when they make a purchase
**the number of customers that remained your customers from last year to this year