So you’ve grown your customer base
Sales keep on growing and you have even implemented some customer retention strategies.
However, you might not know how customer retention is affecting your business from a financial standpoint.
Do you know how much impact each customer has on your revenue?
If not, you might need to look into your customer lifetime value.
What is customer lifetime value?
Customer Lifetime Value or CLV for short, refers to the expected revenue a customer might generate for your business. This can be calculated on a general basis or a customer-specific basis.
This metric takes into account average purchase values, frequency of purchases, and more.
The goal of this metric is to calculate the value a customer will have across its entire “lifetime” with the business.
Why customer lifetime value is important
Knowing your customers’ lifetime value can provide valuable insights on many aspects of your business.
For example, you can compare your CLV to your customer acquisition costs to know how long it takes your business to break even on a new customer. Does it happen with the first purchase? Or the 5th?
You can also calculate the CLV for different kinds of customers and allocate customer retention resources accordingly.
For example, let’s say that you offer a subscription service with both Yearly and Monthly plans. Which set of customers has the highest CLV? The ones buying the monthly plan or the ones buying the yearly plan?
In general terms, Customer Lifetime Values help you see the numbers behind your customer strategies and provide insights on how to plan your strategies forward.
How to calculate a customer’s lifetime value
Now, let’s go over how to calculate a customer’s lifetime value. Luckily enough, this is rather easy.
Before you get started though, you will have to set two parameters:
- Which set of customers will you use for your calculation: Will you calculate CLV for all customers or a specific subset?
- Which timeframe will you use to calculate CLV: Will you calculate CLV on a monthly, quarterly or yearly basis? This depends mostly on your own business cycles and what works best for your business.
Now, with this out of the way, let’s talk about the numbers you will need for your calculation:
First, you will need your Average Purchase Value. You can calculate this by taking the total revenue generated by all customers in your set and divide it by their numbers of purchases or transactions.
Second, you will need your Average Purchase Rate. Calculate this by taking the number of purchases or transactions in your timeframe and divide it by the total number of unique customers in your set.
Next, calculate the Average Customer Lifespan. Calculate this by taking the average number of months/quarters/years that your customers stay active and purchasing from your business.
Lastly, you will need the Customer Value. Calculate this by multiplying the Average Purchase Value by the Average Purchase Rate (both of which you calculated earlier).
Now it’s time to calculate the Customer Lifetime Value.
To do this, multiply the Customer Value by the Average Customer Lifespan. Yup, it’s that easy!
This number will give you the average total revenue you can expect from each customer you acquire.
It is important to note that your Customer Lifetime Value is not a static metric.
Your CLV will change as you implement customer retention strategies and new product offerings. It is recommended that you re-calculate your CLV every so often.
Looking for new customer retention strategies to implement in your business?
Read our ultimate guide on customer retention strategies that work and can increase your revenue.