Why Customer Lifetime Value matters and how to calculate it

Philippe Pavillet

Mar 1, 2023

In today's fast-paced business world, getting caught up in the latest marketing trends and sales tactics is easy. But the truth is, the center of every marketing strategy and the key to long-term success lies in understanding and maximizing the value of your customers. That's where Customer Lifetime Value (CLV - also often known as LTV) comes in.  

Curious about this metric? In this article, we'll explore why it matters and how to calculate it, so you can start unlocking the full potential of your customer relationships, developing targeted marketing strategies, and maximizing your revenue. 

Let’s start by answering this question: What is Customer Lifetime Value? It is the total amount of money a customer is expected to spend on your products or services throughout their relationship with your business. Understanding the CLV of your customers can help you identify which customers are most valuable, which can help you tailor your marketing strategies and allocate resources more effectively. 

But, how can we calculate it? 

To calculate CLV, you'll need to consider several factors, including the customer’s average purchase value, purchase frequency, and the average customer lifespan (the average number of years a customer continues purchasing from your company). Even if the formula can vary depending on the business and the data available, this would be the general one:

CLV = (Average Value of a Purchase x Number of Purchases per Year) 
    x (Average Customer Lifespan)

However, which are the main problems here? 

  • You probably lack data

It is important to highlight that the formula introduced above is just a rough estimate of a customer's lifetime value. In fact, for a more accurate calculation, a data-driven approach is needed, if only to properly measure the Average Customer Lifespan part of the equation. That is why only 42% of companies are able to measure CLV accurately. 

Businesses can make more accurate predictions about future customer behavior by analyzing data on the next order dates and amounts. For example, if a customer has a regular purchase pattern and is expected to make another purchase shortly, their CLV will be higher than a customer who has not purchased in a long time.

Additionally, knowing the expected amount of the next purchase can help businesses estimate the total value of the customer's relationship over time. For example, if a customer typically spends $50 per purchase and is expected to make three more purchases in the future, their CLV will be $200.

This is why at Fructifi, we calculate the CLV at the single customer-level, by adding past revenues with revenues the customer is predicted to make in the future.

  • The calculation remains static if it is not done regularly

Customer Lifetime Value is a dynamic metric that changes over time as customer behavior and purchasing patterns evolve. If calculations are not done regularly, they may remain static and fail to capture changes in customer behavior or even market conditions, resulting in inaccurate or outdated insights. 

Customers' purchasing patterns and preferences may change over time due to factors such as changing needs, competitor offerings, or economic conditions. For instance, a customer who previously made frequent purchases may reduce their purchasing frequency, leading to a lower CLV.

  • It is only really valuable if you calculate it by customer segment

When CLV is calculated by customer segment and, in particular, by customer acquisition channel; businesses know the exact budget they can spend per customer and per channel. 

Once you have calculated the customer's lifetime value, one really valuable metric to track is Customer Lifetime Value to Customer Acquisition Cost (CLV:CAC) ratio. This metric compares the estimated value of a customer over their lifetime to the cost of acquiring that customer, and it is used to evaluate the effectiveness of a company's marketing and sales efforts.

To calculate the CLV:CAC ratio, you just need to divide the Customer Lifetime Value by the cost of acquiring those customers. The resulting ratio provides insight into the return on investment (ROI) of customer acquisition efforts. While a high ratio indicates that a business is generating more revenue from its customers than it is spending to acquire them, a low ratio suggests that customer acquisition costs may be too high relative to the revenue generated. By improving the ratio, businesses are able to improve their profitability and growth over time. 

This way, they can assess the impact of their efforts to retain and acquire customers and adjust their strategies accordingly. Just think how powerful this can be! 

  • It is a time-consuming task if you have a large customer base

For businesses with a large customer portfolio, calculating CLV can be time-consuming, due to the complexity of the calculations involved. Indeed, businesses need to analyze vast amounts of data to calculate it (such as purchase history, frequency, amount, or the cost of customer acquisition). 

Therefore, the CLV calculation may require the use of specialized software or data analysis tools. However, the potential benefits of accurate CLV estimates in terms of optimizing customer relationships and revenue make it a valuable investment for many businesses (Get started here!).  

By using your CLV insights to segment your customers based on value, you can develop targeted marketing campaigns that focus on high-value customers, while implementing retention strategies for customers that are at risk of leaving. In addition, understanding your CLV can help you make better financial decisions, such as setting customer acquisition budgets, pricing products, and even investing in new products or services that appeal to your high-value customers.

In conclusion, you can create a more customer-centric business that not only generates more revenue but also fosters long-term customer loyalty. So if you haven't already, we strongly encourage you to start using this powerful metric to take your business to the next level! 

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