In basic terms, the customer lifetime value (CLV) is the total profit you make from a client for the entire period when they purchase from you. Behind this basic explanation, there is a formula that helps you make this calculation:
CLV = Annual profit from customer x Average number of years they buy – Cost of acquisition
This free resource gives you detailed explanations of how to calculate the customer lifetime value and a free Excel template with the formula.
Why Should You Calculate Customer Lifetime Value?
Some business owners are happy to see sales coming in. But there is a big difference between the customer who makes a one-time $500 purchase and the customer who makes repeated $30 purchases over several years.
In the end, the client who makes small purchases once every few weeks will bring you more profit than the one who splurged on a special discount offer and then stopped buying from you. In fact, once you deduct the cost of acquisition from the sale, you realise that you have negative ROI. That is, your marketing strategy plus the discount you offered cost you more than you made from that client.
How Is Customer Lifetime Value Connected with Your Marketing Strategy?
If you want to find those ideal customers you are dreaming of and to improve your ROI for each marketing campaign, then you need to calculate CLV and use it in your client acquisition strategy.
There are several practical reasons to do so, and we will present them one by one below.
1. Not All Clients Are Equal
We will revert to the hypothetical case presented above. One customer makes a one-time $500 purchase. Another makes repeated $30 purchases. When you look at the overall customer lifetime value, it makes more sense to nurture the client who continues to buy from your business.
Instead of making efforts to attract another $500 purchase from the first client for months, focus on the loyal client and strive to increase their lifetime value. You can try the following:
- Increase the frequency of the purchases
- Determine the client to buy more products during each purchase
- Move from average to premium priced products.
2. VIP Customers Are Expecting Recognition
No customer will send you an email saying “hey, I’ve been buying from you for 5 years, give me a discount”. They will wait for a form of recognition for their loyalty. And if they don’t get it, they will move to a competitor.
Calculating the customer lifetime value has the benefit of helping you recognize your VIP customers. Once you know who they are, you can reward them for their loyalty and, in effect, increase their CLV.
3. Segment Your Customers Efficiently
It is true that not all clients are equal, but you should not give some of them up just because they don’t spend as much as you’d wish. You should continue to send them offers and connect with them. Only, do not spend as much money as you do on your VIP customers.
Strive to send them personalised offers, but don’t cut your margins with large discounts. Send them notifications of a new product launch, but not early access to that product or an invitation to the launch party.
4. Retain Clients Before They Leave You
The churn rate is something every marketer and business owner dreads. It represents the number of clients you lose each year. And CLV calculation can help you reduce this number.
As you perform this calculation year after year, you will notice that some groups of clients have a declining value. This means that they are not buying as much and as frequently as they used to do. Thus, you can quickly create a marketing campaign with discounted offers on their favourite products. It many cases, this is enough to win back your client’s loyalty.
5. Estimate Your Marketing Budget More Accurately
Customer lifetime value allows you to know how much money you should spend for each client group. And this is something any business needs: predictability for its expenses. Knowing the size of your marketing budget allows you to consider how to invest the remainder of your budget – in investments, research and development, expanding your business, etc.