Customer lifetime value (CLV) refers to calculating the contribution of each customer to your business for the lifetime. You indeed have to pay something to get another thing. So, a customer’s lifetime value is the return of your marketing efforts.
Customer lifetime value helps you to improve your services to get maximum ROI. So, let’s study several methods to calculate CLV.
Calculate by CLV Formula
The CLV formula is similar to calculating return on investment (ROI). Subtract the total cost you spend on the customer from the total revenue you got from the customer for the lifetime.
Formula: CLV = lifetime revenue – lifetime cost
You spent 100$ to gain, retain and serve a customer. However, the revenue you generate from that customer is 160$.
Then according to the CLV formula,
160$ – 100$ = 60$
60$ is the customer’s lifetime value.
Well, each customer is different. Some customers make one-time purchases, and some are loyal ones. So, we can only determine the lifetime value of each customer through this formula.
Calculate by Customer Revenue Distribution
Customer revenue distribution is the more reliable method of CLV calculation. Initially, we group the customers based on their purchases.
Let’s assume the groups to make a better understanding:
Group 1: Customer who purchase for 35$
Group 2: Customers who purchase for 70$
Group 3: Customers who purchase for 100$
We must determine how many customers fall into each group to pursue customer revenue distribution.
|Group Number||Number of customers|
Now put the values in the formula to calculate CLV.
Formula: CLV= (group 1 no. of customers x group 1 purchases) + (group 2 no. of customers x group 2 purchases) + (group 3 no. of customers x group 3 purchases) and so on…
CLV= (86 x 35) + (120 x 70) + (156 x 100) = 27,010
Now divide the total value by the total number of customers to get CLV
CLV = 27,010 / 362 = 74.6$
We take into account the one-time customers, the occasional customers, and the regular customers in the revenue distribution method. So, the CLV calculated from this method is more reliable and accurate.
Use Purchase Frequency Rate and Average Order Value
It’s a slightly complicated method of calculating customer lifetime value. Let’s start with the formula of CLV.
Formula: CLV = Customer value x Average customer lifespan
Now, how to get the customer value and average customer lifespan? Analyze purchase history to determine the average customer lifespan. Generally, we take 1 to 3 years as an average customer lifespan.
Customer value is different from customer lifetime value. We calculate customer value through a different formula.
Customer value = Purchase frequency rate x average order value
We must calculate purchase frequency and average order value before calculating customer value.
Purchase frequency rate = the number of orders in a certain period/number of customers in a particular period
Average order value = Total sales / number of orders
Firstly, we must calculate the average order value and purchase frequency rate. Put both values in the formula to calculate customer value. Eventually, multiply customer value by the average customer lifespan to get customer lifetime value.
Multiply Profit by the Lifetime Value
It’s another method of calculating CLV. To calculate it, we will use the formula:
CLV = lifetime value x profit margin
Firstly, we have to determine the lifetime value to calculate further. Here is the formula to get the lifetime value:
Lifetime Value = average customer lifespan x number of transactions x average order value.
Once you get the lifetime value, put it in the first formula to calculate CLV.
Use Calculation Tools
Instead of doing complex calculations manually, you can use various tools to calculate CLV. Some marketing platforms, online calculators, and software are used for this purpose. The tools and software even provide accurate results.
These tools access the purchasing history to calculate CLV. Some tools use artificial intelligence to analyze customers’ purchasing behavior.
Why is Customer Lifetime Value Important?
It is always beneficial to know about the contribution of each customer in your business. This information will help you recognize your potential customers. Hence, you don’t have to waste your time and marketing efforts on the wrong audience.
Once you calculate CLV and know about the insights, you can use them to make business strategies. The following are the advantages of calculating CLV:
- Get a better return on investment by investing in the right marketing strategies.
- Once you recognize your target customers, it will help you to put all your efforts and resources in the right direction.
- Make better retention strategies for potential customers.
- Personalize your services for each group of customers according to their concerned segments.
Businesses calculate customer lifetime value to make customer retention strategies. This value also helps in designing marketing campaigns. Businesses must calculate it regularly to track their business progress.
Manual calculations are good enough to make a rough estimate. However, you can take different tools on board to get accurate values.