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Description: In this article, we discuss what is the customer lifetime value (CLV), how to analyze it, and how it can be beneficial for your business. Learn the formula to calculate CLV and discover the average lifetime value of your customer
CLV: What Is it, and How Analyzing it Can Improve Your Business?
Each client is important, but some lay the foundation and keep you afloat. They exist at the core of your business – sometimes they are responsible for most of your revenue; in other cases, a valuable customer that stays with you is more important than bringing tens of new ones. How to identify them and use the knowledge of their lifecycle to repeat that success? The answer is measuring CLV – an incredibly important metric in every marketeer’s book. What is customer lifetime value? Read on to find out.
1. Defining customer lifetime value – what is it, and how do you measure it?
CLV meaning is, relatively speaking, how much a customer is worth to your business. When the client first receives any information about your business, service, or ware and decides to check it out, their lifetime value begins to accumulate. It sums up the amount of revenue a customer has brought to you, creating a clear picture of the dynamic between your company and them.
Knowing it helps divide your clientele by their behavior and, consequently, improve retention rates. Communicating their value to your old and proven clientele via the targeted campaigns is a classic way of staying in touch you’re your audience. What’s best, it is much more effective (and cheap!) way than the wide-scope attraction of the new clients.
What’s more, by calculating CRV, you can research and build reports on a starting point of what you may consider a perfect client, helping you analyze customer segmentation and repeat the cycle to attract and retain more valuable customers.
It is important to distinguish CLTV meaning from customer loyalty and satisfaction. This metric is linked straight to profits, giving the data that’s backed up by hard numbers instead of concepts. By making a customer lifetime value model, you receive a starting ground for further research. How to ensure client extends their subscription to your service or keeps buying goods? And what to do if anything goes wrong and your number of patrons, especially long-term ones, starts to vanish? Answer it by analyzing your clients’ behavior and how willing they are to spend their money on your services.
2. Analyzing the process: how to calculate LTV?
There is a simple way to calculate lifetime value – to sum all profits from a single client. Let’s imagine the perfect subscriber – each year, on January 1st, they extend their subscription to, say, their favorite streaming service for another year. Their lifetime value is the number of years they’ve been subscribed multiplied by the cost of a yearly subscription.
Above, you can see an example of the historical approach. It is the most simple one and is wholly dedicated to calculating the customer LTV ratio, meaning that the analyst takes the data on purchases anyone has made at your online or offline stores and sum it up, which will equal their lifetime value. Suppose we return to our previous example with the streaming service, though. In that case, it won’t show any correlation with your marketing innovations, take monthly and weekly subscribers into the account, and, in general, can work only for small-time businesses with roughly the same clientele with similar behavior and compare the total revenue from a single, faceless customer.
There is an alternative approach. Instead of analyzing a lone client, you can group them by any metric you find insightful. It is called cohort analysis, and it allows you to analyze the customer segmentation.
Let’s take the time periods for example:
- the month they all subscribed to investigate the dynamic between different months;
- the date of your latest marketing campaign to see how new clients attracted by your ads do compare to other customers;
- Or the date most clients dropped their subscription or made their last purchase to see if there’s anything in common that drove them away.
This approach can let you analyze any number of clients you want. You may select a group of loyal ones that’s been with your business for so long to see what attracted them and what approach they find popular and compare them with the group of clients who didn’t find the services you offer useful. Discover what steps you should take to retain more clients by researching popular measures with already established ones.
The third approach is different and much more focused on behavior than on revenue. It is the predictive customer lifetime value model, and it pinpoints the precise steps on a customer’s journey and uses the past data to predict what a client (or a group of clients) will do in the future and assess their future LTV. The algorithms may seem advanced, but behavioral studies haven’t reached the level of utmost accuracy marketeer needs to ensure their success, so handle it with care as there is little to no difference between prediction and guessing. So, if you wondered how to estimate the lifetime value of a customer – there is a way, but use it on your own accord.
3. Is there the best way to measure customer lifetime value?
The short answer is no; each approach can be used in different situations and fits various businesses. There is a way to ensure your analysis is as accurate as possible, though, so here’s how to calculate CLTV:
The first thing you need to do is to aggregate your data. Partial information about your total revenue from, say, the online store will produce only partial results. Of course, it may allow you to create and analyze a cohort of customers who purchase online, but how do you compare them to offline buyers?
Next, combine your data and upload it to any service that is suited for marketing analytics or, if your business is pretty small, even a simple spreadsheet will do.
The third step is the most important one – you’ll need to identify the events where a client generates any amount of money for your business. It will be a starting point of future assessment and tracing the steps they go through. The most important being when they start making revenue and when your relationship ends.
After, take the revenue from each event that generated profit and sum everything up. That’s how customer lifetime value is calculated, whether you analyze a single buyer or a cohort. From that point, it’s easy to discover the average lifetime value of each user and to start researching their behavior that leads to using your service and paying for it.
4. Which Customer Lifetime Value Model or Formula Should You Select?
What will our calculation look like? Suppose we use the historical model mentioned above. Imagine that 32 clients subscribed in January brought the service 6064 dollars over half a year. We can calculate the average lifetime value with an LTV formula:
A: 32 – number of customers
B: 6064 – gross profit
6064/32 = 189,5 = Average revenue per user (ARPU) for half a year.
Now we can turn to a predictive model to find out what will be an average number per year:
(ARPU for 6 months) * 2 = 189,5 * 2 = $379.
Thus, CLV in this model will be 189,5 if you use the historical approach and 379 if you use the simplest predictive calculation.
Build a table for different months to calculate each month’s revenue from each customer and to find a correlation with your marketing efforts!
Above, you can see the most common and straightforward way to measure the client’s total worth. If we go deeper, we can discover that advanced models take another thing into account – expenses. If your business grows organically and you don’t spend anything on marketing – good for you, but for any viable CLTV formula, the expenses are just as important as profits. If a store makes up 5 thousand bucks in revenue but spends 6k on an advertisement at the same time – they are in deep trouble.
Thus, if you take it into account, then our formula can be corrected. Here is how is customer lifetime value calculated with expenses in mind:
A: 32
B: 6064
C: 1000 – the cost of attracting these customers via the advertisement on social media (or CAC – customer acquisition cost, we’ll take it optimistically this time)
The math goes like this:
(6064 – 1000)/32= 158,25
This calculation takes the expenses into account, giving a more objective number of clients’ value to your company.
This is the simplest way of having the customer lifetime value formula explained.
5. The Most Important Question: How to Improve CLV?
If you’re not in the situation like in the store from the previous paragraph, the one that spends more than makes in profit, then you should be okay. Still, CLTV improvement makes significant changes for every business that decides to work in that direction. First, ensure that your CLV is at least three times more than your CAC, as it is the average ratio on the market. Second, do what any business does in that situation – become client-oriented.
There are a few basic points to working with the clients.
- Analyze your patrons and work with dissatisfied ones. A person stopped buying or subscribing? Find out why and solve that issue. Maintain a great presence on social media to work with them directly and, of course, have a great and friendly image to prevent any negative buzz that may influence the sales.
- While working with clients who are dissatisfied with your services, do not forget about your best ones! Reward them with loyalty programs, discounts, or services, like the right to pre-order an item before anyone else. This way, you will not only enhance their lifetime value but set an example to others who’ll want to reap the benefits too.
- Offer new audience something that your competition does not. Think about discounts and mid-tier benefits that are too low for the most loyal people in your audience but will work just fine for any potential buyers.
Conclusion
CLTV is a great way of keeping in touch with all the people who consume your product. It helps to find the balance – reward those who’s been with your business from the start to send a message about you valuing them and work with clients whose lifetime value leaves much to be desired to find your weak points and improve where it’s needed. Do not forget about this important metric, as it reflects the state of your whole business, handing you over the ability to keep in touch with tendencies in real-time.
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This content is brought to you by Alexandr Ponomarenko.
Photo: Shutterstock
