Customer Lifetime Value: What It Is & How To Calculate It

Christian Cabaluna

Running a business and acquiring customers is already hard enough. Growing it is another story that requires you to use different CRM marketing software and knowing several business metrics.

But in this post, we’ll focus on the aspect of business metrics, most specifically, a metric that allows you to know what customers to focus on.

That metric is famously known as customer lifetime value. This particular metric allows you to know how much dollar value a specific customer brings to your business.

Although it’s an important number to know, most businesses tend to overlook this simply because they don’t know how to calculate it.

But after finishing this post, you’ll know everything about customer lifetime value including how to calculate it and why it’s important for your business.

What is customer lifetime value (CLV)?

customer lifetime value

Customer lifetime value is how much value a single customer brings to your business. The number you come up with in this metric represents the total amount of money a customer is expected to spend in your business. 

If the CLV of an average small restaurant customer is at $500 and the cost of customer acquisition (marketing, advertisements, promos, etc.) is at $800, then you can conclude that the restaurant is operating at a loss.

Without knowing the CLV, the business might not notice that the ROI of their marketing efforts is negative. This prevents the growth of your online business or physical store.

By knowing this metric, a business can rethink its marketing strategies and restructure its sales funnel to increase the value of its CLV and lower the cost of its marketing.

How is customer lifetime value calculated?

CLV equation

There are a lot of variations when it comes to the calculation of a customer lifetime value but you don’t need to know each one of them. All you need is the simplest way to get this value:

  • CLV = average value purchase x purchase frequency x average length of the customer relationship (in years)

Let’s put this into context:

Innocent Drinks is a global company that sells juices and smoothies to its customers.

An avid customer who buys their smoothies could be worth:

  • $5 per purchase of smoothie drink x 104 smoothies per year (buys twice a week) x 5 years of being a loyal customer = $2,600

An average customer who buys their juices could be worth:

  • $2 per purchase of juice drink x 104 juices per year (buys twice a week) x 5 years = $1,040

Given the data above of which set of customers bring more dollar value to the company, Innocent Drinks now knows which set audience should they advertise more to and which group should they spend more on customer retention.

This also works on a business that’s in the services sector. Take language teaching services for example.

A client who takes English courses could be worth:

  • $400 to finish a course x 2 English courses per year (beginner and advanced courses) x 1 year = $800

While a client who takes Spanish courses could be worth:

  • $500 to finish a course x 2 Spanish courses per year (beginner and advanced courses) x 1 year = $1,000

Now for this example, it’s clear that a client who takes Spanish courses brings more money into the business. But of course, the business also needs to account for how many clients take Spanish courses vs. English courses. 

Your customer lifetime value isn’t just knowing how much money a customer can bring to your business - it’s just one aspect of it. Knowing your CLV also gives your business an insight into if there are any changes needed to be done in your marketing.

The connection between customer acquisition cost and customer lifetime value

You might wonder why we’re talking about customer acquisition cost (CAC) when this article highlights customer lifetime value? Well, knowing the relationship between CAC and CLV can also help in growing your business.

Firstly, the meaning of customer acquisition cost is simply what its name states - the cost of acquiring a customer. This encompasses all the money you’ve spent on your marketing efforts. This includes all marketing campaigns both offline and online.

Second, as we defined earlier, customer lifetime value is how much revenue a single customer contributes to your business. 

Now the connection between these two metrics will tell you whether your marketing campaigns are performing as expected.

When it comes to both variables, you need to have an inverse relationship between them with the CLV having the higher value. Why? Because this means that the higher your CLV is and the lower the CAC value, the more profit you’ll stand to make.

When the CAC is higher than the CLV, it only means that you’re spending more on marketing than the dollar amounts your customer is willing to spend.

If you’re looking for the ratio, just divide the CLV by the CAC. 

Why is customer lifetime value important?

As mentioned earlier, calculating your CLV goes beyond knowing the dollar value of your clients, it can help a business grow and give its customers a better customer experience.

To convince you more of the importance of CLV, take a look at these benefits:

You’ll know what products your high CLV customers want

With this information alone, you’re able to increase your revenue by marketing the right products to customers who are willing to spend more frequently with your business.

If you’re looking at your clients as equal paying customers, then you’re completely wrong. By calculating the CLV, you’ll see that there will always be customers who buy more and frequently than the rest.

You can determine which customers you are going to spend more marketing efforts on and which one you should spend effort on retaining. 

Ideally, you’d like to retain your high CLV customers since they already have a higher frequency buy rate than the low CLV customers. For the ones who are on the low CLV value, you should think of how you can market to them effectively so they’ll spend more on your business.

You can upsell your saleable products

There’s a reason why your customers buy your products. It usually is because your products solve a problem or it can make something in their lives easier. 

Whatever it is, you can always sell them a better version of it. This is how some businesses grow using upselling. They sell an upgraded version of a product that’s either more effective or faster.

So how does CLV help with this? It can help by letting you know which products have the highest profitability. And with this, you can upsell the higher version of these products to your customers.

You’ll know what type of customers are the most profitable

Businesses that sell a variety of products deal with different types of customers. Just like the example above, Innocent Drinks deals with consumers who like their smoothies, juices, and other products.

Calculating each of the CLV will let you determine which among the subset of your audience pays more. And it’s up to you whether you double down your marketing efforts on those customers or you put more effort in making the other types spend more. 

Either way, it helps boost your business’ revenue. 

Now that you know what customer lifetime value is, how it’s calculated, and why it’s important, it’s time to know how you can improve it.

11 ways to improve your customer lifetime value

1. Segmenting your email list

Email marketing is still one of the top channels that businesses use to promote their products. That’s why marketers still spend ample time to find business emails, contact numbers, and names to grow their list.

Now that you know the concept of CLV, don’t use a one-size-fits-all email marketing campaign. What you can do is segment your list depending on the interests of your customers.

For example, customers of a financial service company will have different interests. Some are more interested in what cryptocurrency to buy while others would like to know more about NFT platforms, and some just like to learn about stocks.

Segmenting your email list and creating customized content for people with different interests will yield much greater results for your email marketing campaign and a higher conversion rate.

The more “personalized” an email is or the more the email is constructed to a customer’s interest, the more they will be engaged and be inclined to buy a product or use a service.

2. Take care of your clients

This might be a no-brainer but some businesses don’t follow up on their customers after the transaction is done. 

If you want to increase customer retention, customer loyalty, and buying frequency, you need to take care of your clients.

  • You can give them coupons for your business. Statistics show that 94% spend more at a store when they use coupons.
  • Read online reviews - check what people have to say about your business. Thank them or address their issues.
  • Give them exclusive discounts
  • Create a feedback form asking how you can better serve them
  • Hold online events or virtual conferences to know them better and create a community.
  • Have an excellent return policy

3. Educate your customers to improve their current state

If you’re in the service industry, your clients are coming to you because you solve a certain problem they have. 

And a way to give back to your clients is to teach them something that they can benefit from. 

If you’re a digital marketing agency, teach them how they can improve their website ranking or provide them with an SEO tool. If your target market is students, give them study materials that they can use.

Doing these acts will go a long way. Your customers will appreciate your business teaching them a thing or two about your strategies and secrets that can improve their current state.

Take a look at how iNecta, a SaaS company, uses its platform to teach its clients to learn more about the intricacies of running a business and how they can be more efficient in managing inventories.

iNecta blog

Aura, who’s an authority in the Amazon selling niche, teaches sellers how they can automate their Amazon FBA business and other topics on Amazon selling.

On the other hand, VPNoverview teaches its readers all about cybersecurity for free with nothing to sell.

4. Provide something that your competitors can’t

A way to separate you from the pack isn’t limited to giving discounts and promos. It could be how you conduct your service and the products you sell.

great customer experience

If you can’t do it through these things, your business can be unique by how you serve your customers. We all know those businesses that have exceptional services that make us want to come back to its premises every time. 

Another unique way to get an edge over your competitors is through hosting a podcast. This allows you to be connected to your audience even more. 

Although it might seem like starting a podcast and looking for podcast hosting services might be a hassle, the ROI of this activity can benefit your business in terms of exposure and sales.

Podcasts are a hit right now. People listen to it while they go to work, when they’re relaxing, or even when they’re at the gym. 

5. Create loyalty programs

If you want to increase their buying frequency and have a long relationship with your clients, loyalty programs can do the trick. 

Loyalty programs fall under the big umbrella of loyalty marketing. They are specifically designed to incentivize customers when they choose to do business with you.

Loyalty programs are even used by sellers in top eCommerce platforms like Shopify and Amazon. Store owners incorporate this strategy because it simply works. 

Customers would rather spend money on a business that incentivizes them. Since they’re already spending their money, they might as well get something back in return.

6. Be easy to be contacted

No matter how we try to make our business perfect, that just can’t be achieved in today’s world. Sometimes, your product can have malfunctions or your service might have some lapses.

When these unfortunate scenarios happen, your business needs to be easily contacted. And this is where having a social media account comes into the picture. 

Nowadays, people who are looking to contact a business directly go to social media. They search for the business and contact them there.

Take a look at how Mixam provided all the details on where their audience can reach them:

Mixam details

It is complete with a phone number, email, and their different social media accounts. 

Some businesses even incorporate a chatbot so that customers who have questions can use it to answer basic questions.

If your customers can’t find you to address their issues, you run the risk of them not doing any business with you anymore. You might’ve missed the opportunity of converting a customer to a repeat client.

7. Monitor your social media

You have to understand why people are looking for businesses on social media. The reason is they want a fast response from your end.

With the rise of 24/7 customer service and the usage of chatbots, businesses have no excuse not to cater to an issue of a customer no matter what time of the day it is.

If these people don’t get the service they expect, chances are they’ll be all over social media complaining about your product and service. They’ll be tweeting and creating posts about their experience with your business. 

It’s important to do everything you can to address these issues quickly. If you have the resources, hire a person that solely focuses on this aspect of your business. 

That’s why big companies have a whole team dedicated to this business concern only. They know how much of an impact this can have on the business.

8. Create engaging ads

We mentioned above that customer retention is a much cost-effective way to boost profits than customer acquisition but this doesn’t mean that we should completely stop doing marketing. 

Marketing is one of the pillars of a successful business. The way they engage their customers through their ads is how they acquire new clients and assure the old ones that they’re transacting with the right company.

Videos are a great way to create engaging advertisements. Creating videos is still one of the top eCommerce marketing strategies out there.

If you’re not outsourcing videographers, just make sure to read some tips on how to make your videos look professional

But engaging ads aren’t just limited to videos, it can also come in the form of print advertisement or other traditional strategies. 

An added benefit of having a great and engaging advertisement is the chance of getting free press which extends the reach of your advertisement. 

Take a look at this clever print ad by KitKat during the lockdown period:

kitkat ad lockdown

Genius, right? Now take a look at how a simple advertisement got different publications talking about it:

Kitkat ad on Google

9. Make the buying process fast, smooth, and safe

You’ll never see a high buying frequency in your CLV formula if you can’t make your buying process fast and smooth for customers. This applies to both physical and online stores.

When your customers are at the checkout page or the counter, the last thing you want to do is bombard them with questions, forms, or unexpected shipping fees. These things are major turn-offs and can increase your cart abandonment rate.

Another important factor that they consider when on the checkout page would be whether the transaction is safe. You need to assure your customers that transacting with your business is safe and secure.

You can add trust badges all over your website or you can dedicate an entire page about safe and secure shopping like how Mannequin Mall did:

Mannequin Mall safe and secure shopping

So it’s very important to eliminate any variable that can make that happen. Eliminate friction and unnecessary forms to make for a better customer experience.

10. Show your appreciation

Don’t be one of those businesses that don’t talk to their clients after a purchase is made. What you can do is provide a thank you note with every purchase, send a welcome email, or even surprise them.

If you don’t want to manually do these things, consider using email software that allows you to automate this process.

Doing these extra steps helps you build your online brand or overall business in general.

These acts go a long way and will be appreciated by your customers tremendously. It’s a genuine way to make your brand stick to your customer’s mind for a long time.

11. Don’t go back on your word

If you received a complaint and you solved it by compensating the customer, make sure you do everything you can to deliver on that promise. 

If your marketing campaign advertises that your products or services do this or that, it must live up to what is said in the campaign.

When transacting online, people always have their guards up. They’re very cautious about who they’re transacting with and whether the business is a scam or legitimate. 

With the number of scams that happen online daily, you can’t really blame them. That’s why you must not go back on your word.

You don’t want your business to be tagged as scammy. That’s the last thing you want to happen. You don’t want false advertising ruining the reputation you’ve built throughout the years.

Final thoughts on improving your CLV

These strategies above aren’t just theories you learn from digital marketing courses. These are tried-and-tested ways to improve the current relationship between you and your customers.

As you might have noticed from what you’ve read above, almost all of these improvement strategies are centered around your customers. 

This just shows that if you want to increase the value of your CLV, you need to focus on your clients - make them feel special, let them have a great experience, show your gratitude and appreciation.

These small acts can eventually give massive results for your business.

Conclusion

Given the benefits of determining customer lifetime value, you must study this metric and improve it over time. Having a high number for this metric equates to increase royalty which ultimately boosts your company’s revenue.

If you haven’t tried out this metric, then now is a good time to start. Focusing on your customers can only bring positive things to your business. Since, after all, they’re the ones who are fueling your business to continue running.

Apply the tips above and you’ll see that the value of your customer will increase over time. 

Christian Cabaluna

Christian Cabaluna is a finance blogger at awesomex™ with 5+ years of first-hand experience.

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