A Beginner's Guide to Understanding and Measuring Customer Lifetime Value (CLV)

Nick Shaw

Lifetime value is a common term in sales and marketing. It simply refers to the total revenue a client will provide to your business. It can often be confusing, though, even for experienced marketers. There are many variables to a Customer Lifetime Value (CLV). 

Even the best way to calculate CLV can vary depending on your business. We’ve put together this guide to explain everything from CLV basics to advanced tips on improving it. So, whether you’re new to the term or not, read on to reveal the mysteries of CLV.  

What is CLV?

Customer Lifetime Value is the total value a customer will provide your business. In a simple example, a customer who subscribes to a monthly service makes twelve payments a year. If they subscribe for one year then the CLV is their subscription cost x 12 months. 

There’s more to it than this, though. CLV represents the long term value of repeat business. It can be used to inform marketing strategies. It can also be used to show the true value that your customer acquisition cost (CAC) provides. 

To use CLV as a valuable data point. We need to understand a little more about how to calculate it. 

How to calculate CLV

The CLV calculation above is too simple. For one, it’s only showing the value of a single user. Hopefully, your business will have a few more clients than that. 

To get a CLV figure that’s useful to the business, we’ll need some more information. First, you need to know your Average Revenue per User (ARPU). This is the average value of all your subscribers, users, or accounts. 

Let’s look at a simple example for a SaaS business. Say you have 100 users. 30 clients pay $100 a month. Another 30 clients pay $75 a month and the last 40 clients pay $50 a month. The ARPU would be the total revenue divided by the total number of users.

(100 x 30) + (75 x 30) + (50 x 40)  / 100 =  72.5  

So the ARPU here is $72.50. To calculate CLV from this, we need to multiply this figure by the average customer lifetime. Let’s say that the users in the above example stay with the service for 12 months on average: 

ARPU x Average Customer Lifetime = CLV

72.5 x 12 = 870

The CLV would be $870. It can be complicated to work out your average customer lifetime in a real business scenario, though. One figure that you probably already have access to is your customer churn rate. You can also use this to help calculate CLV.  

ARPU / Churn Rate = CLV

72.5 x 0.1 = 725

For the above example, we have assumed that for every 100 customers, 10 will not continue to use the service. This gives us a churn rate of 10%. As you can see, this gives us a different figure. Using churn rate can help account for revenue variances.

The scientific method

For CLV data to be accurate, it’s important to take into account the scientific method. The data you use to calculate CLV has to be statistically significant. This means that your sample size must be representative of the size of your customer base.

For less than 100 clients, you need at least 50% included in the data. Ideally, at this low sample size, you should include all users. For around 1,000-10,000 clients, you need to sample at least 10% of them. At over one million users, the sample should include at least 1% of that total.

Representative data is important. A skewed sample can give you false information about your CLV. This can have an impact on further decision making.   

Why is CLV important?

Now you can calculate CLV in a way that’s useful to your business, there are many ways you can use this data to feedback into your continuous improvement strategy. It can help you improve your service and eliminate points of attrition on your customer journey.

Knowing your CLV can help you make decisions on pricing, marketing, and overhead costs. Monitoring any change in CLV over time will give you insight into your ideal price point. It can also be used as a metric for the success of loyalty schemes and promotions.

CLV can also be broken down into customer segments. This lets you identify your highest value customers. These users stay with your company the longest and spend the most on your products. Gain their feedback and use this to improve your overall customer retention. 

The relationship between CLV and acquisition cost

One of the primary benefits of CLV is the insight it gives into the value generated by your Customer Acquisition Cost (CAC). If you know how much revenue each customer will generate,  you can assess CAC as a proportion of that.

If you’re not familiar with CAC, it’s the average amount you spend to acquire a new customer for your business. It’s normally made up of marketing and sales costs. The number of new customers over a year is divided by your sales and marketing costs for that period.

To get an idea of whether your CAC is where it should be, divide your CLV by your CAC. For example, if your CLV is £500 and your CAC is $100, 500/100 = 5. This means that CLV is five times your acquisition cost, which is a great return on investment for your business. 

If the CLV comes out as less than three times the CAC, you may be spending too much on marketing or spending on inefficient channels. For instance, a low ecommerce conversion rate might mean you’re targeting the wrong audience. 

If you’re a larger business dealing with multichannel order management, it can be useful to break down CAC by channel as well. You can work out separate CLV figures by channel and compare. This will give you valuable information on your most profitable marketing channels. 

Why churn rates matter to CLV

We spoke about churn rates when calculating CLV. If you’re used to dealing with churn rate figures, you know it’s not always that simple to work out. Churn can vary over time. 

Subscription-based services normally see higher churn rates after the initial subscription period ends. However, churn among those customers who stayed after the initial period drops off dramatically. 

You can account for peaks and valleys like this by making more conservative CLV estimates. Either apply a discount rate to your formula or ensure that your churn figures are averaged over a representative time period.    

How to improve CLV

We now know how to calculate CLV and how useful it can be. What we need to learn next is how to improve it. 

Customer feedback

Start with your most valuable customers. Get feedback from those customers that have the highest CLV. 

You can send marketing survey requests or use ongoing customer satisfaction metrics. What you want to know is why these customers return to your business. Find out what unique features you offer that separate you from your competitors. 

If you find out what kind of customers get the most out of your business and why, you can use this information to improve your services, update your FAQs, and improve your targeted marketing. Then you’ll attract more high-value customers and increase your CLV overall. 

Customer experience

You can also get valuable insight from your lowest value customers. Identify your lowest CLV clients. Then, focus on where points of attrition happen and look to improve these stages of the customer experience.

For example, you might need to upgrade your POS software to create a better retail experience. This can create more repeat retail sales and increase your retail merchandising options. (See here for a great retail merchandising definition.) 

Pricing

The easiest way to increase CLV is to increase your prices. We know it’s not quite that simple, though. Increasing prices too quickly will drive away business. What you can do is use changing CLV figures to judge the impact of price rises over time. 

Use your CLV data as part of a continuous feedback loop. You can analyze how increasing or decreasing prices affects CLV over time and find your ideal price point this way.  

Multichannel strategy

As we mentioned above, CLV can help you identify your most effective marketing channels. By more effective targeting on these channels, you can increase your CLV over time. 

Using the same principles, identify your most valuable marketing partners. Use this information to introduce or optimize a partner relationship management strategy

Costs

Knowing your CLV can help you set upper limits for your acquisition and operating costs. If you have an accurate forecast of your potential revenue, it’s easier to know how long it will take to recover large one-off costs like investment in a new small business phone system.

Of course, finding ways to decrease acquisition and operating costs will increase CLV as well. Even finding unique cost-saving measures like adapting to more efficient remote working methods can help.   

Conclusion

It’s important to know your CLV, sure. You should see by now that it’s more important to use this data properly. CLV should provide an important data point that feeds back into your sales and marketing strategy. 

When you use your CLV information effectively, you can decrease churn rates and improve your customer experience. Not to mention improving your overall marketing strategy. CLV is an important focal point for your marketing data analysis. 

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Nick Shaw

Nick Shaw has been Chief Revenue Officer (CRO) of Brightpearl, the number one retail-focused digital operations platform encompassing sales and automating inventory management, accounting, logistics, CRM and more.

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