Customer Lifetime Value: How to Calculate It and Why It Matters for Your Success

The Customer Lifetime Value (CLV) is a key indicator for assessing the long-term profitability of your customers. This value, in fact, represents the amount of money a single customer will bring your company over time.

What does that mean?

Customer Lifetime Value helps you identify your most important customers, the ones who generate the most value for your business, and direct your resources toward them (in terms of offers, communication and opportunities) to build their loyalty even further and increase their value even more.

In the world of marketing it’s a rule always worth keeping in mind: it’s simpler and cheaper to retain a customer you’ve already acquired than to push a new contact to become one. Acquiring a new customer is, in fact, 6-7 times more expensive, and a 5% increase in retained customers can increase company profitability by 25-95% (Source: Harvard Business Review).

In this article we’ll go deep: we’ll look at what CLV is, how to calculate it, and how to use it to support your business’s success.

 

What Is Customer Lifetime Value?

CLV is an economic indicator that measures the amount of money a single customer will bring your company over time. This value helps you see firsthand how important each customer is to your business, and allocate your marketing and promotional resources toward the most profitable ones.

Customer Lifetime Value is a long-term indicator and accounts not only for current sales, but also for the customer’s future potential.

 

CLV and the Customer Relationship

The customer relationship is a fundamental concept for running a business and for its long-term growth. It refers to the interaction between a company and its customers and covers every activity carried out to create, develop and maintain a positive bond between the two.

That’s why it’s considered a critical factor for a company’s long-term success, since it influences retention, satisfaction and customer value.

The Customer Lifetime Value (CLV) is a metric that quantifies the total value a customer will bring the company over time and helps the company identify its most valuable customers. On top of that, CLV makes it possible to develop strategies to increase their loyalty: upselling and cross-selling activities.

A good relationship with customers matters because it can lead to greater loyalty to the company and to higher sales and long-term value.

To develop and maintain a solid relationship with customers, companies can adopt various strategies, including:

• offering excellent service
• listening and responding to requests
• personalizing the experience
• offering loyalty programs
• maintaining constant, transparent communication.

 

How to Calculate Customer Lifetime Value

Calculating CLV is a process that requires some basic information about your customers’ buying habits. Here are the steps needed to calculate it.

1. Determine the average transaction value: this value represents the amount of money a customer spends on average each time they make a purchase.
2. Calculate the number of annual transactions: this number gives you an idea of your customer’s buying habits and their future potential as a loyal customer.
3. Determine the average length of the customer relationship: this number represents how long a customer will stay active as a buyer of your products or services.
4. Calculate the churn rate: that is, the number of customers who end their relationship with your company each year. You could compare it to a dropout rate.

Once you’ve gathered all this information, you can move on to the calculation.

Use the following formula:

CLV = (average transaction value) * (number of annual transactions) * (average length of the customer relationship) / (churn rate).

In this formula, the average transaction value from a customer refers to the average receipt amount for a customer over a given period of time (for example, a year), while the average length of the customer relationship accounts for how long a customer will stay active as a buyer of the products or services the company offers in its reference market.

It’s important to note that this formula gives only a rough estimate of CLV, since future revenue and expenses can’t be predicted with certainty.

Another thing to keep in mind is that your CLV value changes over time and is influenced by your marketing actions. Take, for example, a price increase on your products: it could produce an increase — even a significant one — in your average receipt; however, it could also push consumers to buy fewer products, less frequently, or to switch to a competitor with lower-quality products at lower prices.

Customer Lifetime Value provides a good indication of a customer’s long-term value to the company and can be used as a starting point for planning marketing activities and customer relationship management.

 

Examples of CLV Calculation

Let’s put what we’ve covered into practice with a couple of simplified examples (which don’t account for churn rate).

The first refers to a simple coffee bar. Let’s assume the shop has an average receipt of €4. The most common customer is an office worker who stops by for a coffee in the morning or during lunch break, on average twice a week, 50 weeks a year (accounting for working days, vacation, etc.) for an average of 5 years.

The formula, then, will be:

CLV = €4 (average sale per customer) x 100 (annual visits to the bar) x 5 (years) = €2,000

Each customer is worth about €2,000 to the coffee bar.

Example number two: subscribing to a SaaS plan (Software as a Service).

Let’s start from an assumption common to many companies, namely that there are several subscription plans. Let’s account for the average monthly spend of the typical customer, which is €17.

On average the subscription is canceled after 3.5 years, thanks to the convenience of automatic monthly renewal.

CLV = €17 (average sale per customer) x 12 (annual purchases) x 3.5 (years) = €714.

 

How to Use Customer Lifetime Value for Your Business’s Success

And once you’ve calculated it, then what? You’re halfway there!

You can use this information for several purposes, all tied to your business’s success.

• Customer retention: knowing your customers’ CLV will help you identify your most valuable customers and direct your attention toward them to strengthen their loyalty (nurturing). For example, you could send them exclusive discounts through newsletters, or set up loyalty programs aimed at customers with a high CLV. Another example is the points collections and loyalty cards that supermarkets — and retailers in general — use to gather information and then profile consumers with the goal of offering personalized promotions, whether individual or clustered.
• Resource allocation: knowing your customers’ Customer Lifetime Value, you can decide how to allocate resources to get the maximum return on investment (ROI). How much of your marketing budget will you dedicate to acquiring new customers? How much to nurturing the ones you already have? As you know, retaining an already-acquired customer costs less and increases company profitability more than proportionally, but it’s unrealistic to give up on acquiring new customers if you want your company to grow in the long term.
• Improving your sales strategies: CLV will help you identify sales opportunities you might be underestimating, such as developing strategies to increase purchase and/or repurchase frequency, or increasing the quantity of products bought per order, thereby increasing your average cart value. For example, you could offer complementary products to customers who’ve already bought from you in the past, or give your customers the option to subscribe to monthly plans with a small discount.
• Assessing long-term sustainability: Customer Lifetime Value will help you assess your business’s long-term sustainability. If your customers have a high CLV, it means your business is sustainable over the long term. If your customers’ CLV is low, you might need to revisit your strategy to increase their loyalty and their value. You might need to work on your brand or your communication, perhaps with a rebrand that lets you increase perceived value and position yourself better in your reference market.

That’s the theory, but how can we use this data to make business decisions? Let’s take inspiration from some major companies that have used it well.

 

How to Use CLV to Optimize Your Strategy

There are several strategies you can put into action thanks to the awareness Customer Lifetime Value gives you. In this section we’ll look at a few approaches.

Attracting New Customers and/or Pushing Them Toward More Than One Purchase

To ensure growth for your company, you need to increase the number of customers using your product or service. There are two ways to do that:

1. Acquire new customers

Identify the customers who bring the most value to your business and outline the corresponding Buyer Persona(s). Study their behavior: which products do they buy? In what way? Where are they? How do you reach them? Your goal is to know them as well as you possibly can, so you can understand how to reach consumers similar to them and push the undecided ones (whom you’ve already brought into your sales funnel) toward their first purchase. You can do all this through strategic analysis and the resulting Digital Marketing Plan.

1. Bond your best customers to you

Having a growing customer base and a broad fan base that keeps buying also lets you have more budget to spend on acquiring new customers, who will then need to be nurtured so they become brand fans who buy regularly.

Focusing on Customer Retention can help you reach strategic goals such as:

• reducing Churn Rate (the rate at which customers stop buying from you) with targeted promotions
• optimizing Churn Rate by deliberately choosing which less profitable customers to let go of, so you can focus on the others
• encouraging loyalty
• improving long-term profitability and business stability.

Optimizing Your Marketing Strategy

Customer Lifetime Value is closely tied to so-called “buying patterns,” the recurring behavior patterns customers display when they buy.

You’re trying to predict, with the highest possible degree of accuracy, what your customers will buy next time and the likelihood that it will happen.

If used well, CLV leads you to focus on the best way to make your business work by putting yourself in your customer’s shoes, with a “full-funnel” approach that covers every stage, from awareness to loyalty. It encourages you, then, to make the best use of the resources available to you, such as Paid Advertising activities on Google and on social media.

Customer Lifetime Value also lets you build tailored strategies. By knowing the CLV for each individual product, you can understand which products are more profitable, and why.

These can be products that:

• drive repeat purchases of a single product or attract more organic purchases (without the use of ads) over time. An example is so-called entry-level products, the ones that let customers “test” the brand and its quality before committing to a higher-tier purchase, whose perceived risk is much greater
• push customers to buy more than one of the products you offer — in both the short and the long term. This is the case with bundles.

To increase CLV you can launch one-off campaigns specific to a time of year (for example, Black Friday) with significant, but time-limited, price cuts on your bestsellers.

You could also think about promotions that reward your most loyal customers, for example by giving them a digital coupon code, early or exclusive access to sales, a fixed discount percentage, or free shipping.

 

Conclusions

In conclusion, Customer Lifetime Value is an important indicator for assessing the long-term profitability of your customers.

Knowing this figure lets you direct resources toward your customers to build their loyalty, develop more effective sales strategies, and assess your business’s long-term sustainability.

Calculating CLV is a smart investment that will help you grow and keep your business profitable in the long term.

Did you find this article useful? Learn more about other marketing indicators that let you:

• optimize your e-commerce conversions (Conversion Rate)
• discover which and how many customers are promoters of your brand (Net Promoter Score).

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