How do you measure your online store’s success? Do you typically focus on things like sales and revenue?
While these metrics are useful for tracking the short-term performance of content and campaigns, they don’t always paint a complete picture of your business’ future. Even looking at your current sales numbers can sometimes leave you with just a fleeting glimpse of your true financial situation.
Customer lifetime value (CLV) is one of the most important factors in determining your business’ present and future success. It’s an often-overlooked metric that can accurately predict how much your customers are really worth.
By measuring the net profit that you’ll take in over the course of your entire relationship with a customer, you’ll be able to narrow down exactly how valuable they are to your business.
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Why is customer lifetime value important?
CLV gives you crucial insight into how much money you should be spending on acquiring your customers by telling you how much value they’ll bring to your business in the long run.
Rather than just racing to keep your head above water, you’ll be able to understand which customers you should be focusing on and, more importantly, why you should be focusing on them.Customer lifetime value is a clear look at the benefit of acquiring and keeping any given customer. Not all customers are created equal.
Understanding your CLV has three main benefits:
- It drives repeat sales and revenue. CLV uncovers the customers that spend more in your store. It helps you understand what products they enjoy and what products improve their lives. You can use CLV to track the number of sales per customer and strategize ways to increase repeat purchases and profit margins. A 5% increase in customer retention can lift revenue by up to 95%.
- It boosts loyalty. The tactics you use to increase CLV can improve customer support, products, referrals, and loyalty programs, which leads to more repeat customers and a higher retention rate. Retained customers buy more often and spend more than newer ones.
- It reduces your lifetime value (LTV) to customer acquisition costs (CAC) ratio. Our research shows that average customer acquisition costs between $127 and $462, depending on your industry. A good LTV/CAC ratio is 3:1, which signals the efficiency of your sales and marketing. By improving your customer lifetime value, you can benchmark how marketing impacts customer profitability.
As a business owner, you need to be able to focus your efforts on acquiring the right customers—the customers who will take your business from being a flash-in-the-pan success to a household name.
While it’s an important metric, customer lifetime value calculation is difficult. If you’ve tried to uncover your CLV in the past, you’ve probably found yourself knee-deep in complicated algorithms and formulas.
Thankfully, there are much simpler ways to calculate your CLV, but don’t let the simplicity fool you— the complexity of other formulas isn’t without good reason. Customer behaviors are very difficult to predict and can seem completely random at a glance, which makes CLV an inherently complex measure to track.
Just think about it. Some of your customers might make small purchases every week, others might make big purchases once a year—and there are all sorts of combinations in between. How can you possibly predict how much your next customer will actually contribute to your business?
CLV takes some of the mystery out of knowing how your current and future customers will behave. By calculating your CLV, you’ll be able to understand how often certain types of customers will make purchases and when those same customers will stop making purchases for good.
Although there are some more advanced methods for forecasting CLV out there, the strategy that we’ll be covering in this post is a straightforward way for you to get the information you need to refine your approach to customer acquisition.
With this simplified approach to customer lifetime value, you’ll easily be able to take a snapshot of your customers’ purchasing history and flip it into a widescreen forecast of their future actions.
Segmenting your customers with RFM
Before we dive into Customer Lifetime Value, let’s take a look at the foundational elements of analyzing customer value: recency, frequency, and monetary value (RFM).
RFM is a technique for organizing your customers from least valuable to most valuable by taking into account the following factors:
- Recency refers to the last time that a customer made a purchase. A customer who has made a purchase recently is more likely to make a repeat purchase than a customer who hasn’t made a purchase in a long time.
- Frequency refers to how many times a customer has made a purchase within a given time frame. A customer who makes purchases often is more likely to continue to come back than a customer who rarely makes purchases.
- Monetary value refers to the amount of money a customer has spent within that same time frame. A customer who makes larger purchases is more likely to return than a customer who spends less.
By segmenting your customers with RFM, you’ll be able to analyze each group individually and determine which set of customers has the highest CLV.
To use RFM to organize your customers, you’ll need to grab three pieces of data about every individual customer: the date of their most recent transaction, the number of transactions they’ve made within a consistent time frame (a year will work best), and the total amount they’ve spent during that same timeframe.
If you own a Shopify store, you’ll be able to find all of this data in the Reports section of your Admin.
Head to Reports and click Sales by Customer Name. You'll be able to find data like order count and total sales for every customer.
For RFM calculations, each of these variables needs to be given a scale. The simplest way is to use a scale of 1 to 3. This might seem a bit confusing, but don’t worry, it’s not as complicated as it looks. Remember: this scale is just a way to help you visualize which groups of customers are most valuable.
You’ll be assigning a value of 1 to 3 for each your customers’ recency, frequency, and monetary value. Think of these three values as categories: 1 being the least valuable, 2 being somewhat valuable, and 3 being the most valuable.
So, when you sort your data, your least valuable one-third of customers will get assigned a score of 1, the third above that will get a 2, and so on.
To help you get a better idea of how this might work, let’s take a look at an example spreadsheet.
For this spreadsheet, I’ve already collected my customers’ information and broken down each variable into three categories based on my data. To do this, I’ve taken the range of data for each variable and divided it into three equal segments.
As an example, for recency, customers who have made a purchase within the last four months are given a 3. Customers who have made a purchase within the last four to eight months are given a 2. And customers who have made a purchase within the last eight to 12 months are given a 1.
Now, we’ll add up the score for each customer and list a total under RFM Score.
Finally, sort your chart by RFM score and divide your results by highest (shown here in red), middle (orange), and lowest score (yellow).
Your highest scoring results will be your most valuable customer segment—be sure to dive into the data to try and find common threads between these customers that could indicate why they provide more value and how you can target them better.
Customer lifetime value formula
Now that you’ve segmented your customers with RFM, it's time to determine the value of each segment to see which of your customers perform the best.
To calculate the customer lifetime value for each of your customer segments, you’ll need to track down three key pieces of data within your pre-established timeframe: average order value, purchase frequency, and customer value.
Average order value
Average order value represents the average amount of money that a customer spends every time they place an order. To get this number, you simply need to take your total revenue and divide it by your total number of orders.
If you own a Shopify store, you can find this information by heading to the Reports section of your Admin and taking a look at your sales by month. You’ll just need to divide your total sales by your order count for the past year.
Note: To get a more accurate number, be sure to click Define under Total Sales and uncheck everything except for Subtotal.
Average Order Value = Total Sales / Order Count
Purchase frequency represents the average amount of orders placed by each customer. Using the same time frame as your average order value calculations, you’ll need to divide your total number of orders by your total number of unique customers. The result will be your purchase frequency.
Shopify store owners can also find this data in their Reports under Sales by Customer.
Purchase Frequency = Total Orders / Total Customers
Customer value represents the average monetary value that each customer brings to your business during a time frame. To calculate your customer value, you’ll just need to multiply your average order value by your purchase frequency.
Customer Value = Average Order Value x Purchase Frequency
How to calculate the lifetime value of a customer
Now that you have the customer value for each segment of your customer base, calculating the CLV is as simple as taking your customer value and multiplying it by the average customer lifespan.
Your average customer lifespan is the length of time that your relationship with a customer typically lasts before they become inactive and stop making purchases permanently.
When it comes to customer lifespan, it’s important to understand the difference between being a contractual and non-contractual business.
Most online stores are non-contractual, meaning that once a purchase is made, the transaction is effectively over. The difficulty with these types of businesses is in identifying when an active customer (someone who makes purchases and will continue to make purchases) becomes an inactive customer (someone who will never make a purchase from your business again).
However, some online stores, like subscription-box-based businesses, fall into the contractual category. With a contractual business, you know exactly when a customer becomes inactive because they announce it when they end their contract or subscription. With a contractual business, it’s much easier to identify your average customer lifespan.
If your store is brand new or has only been around for a few years, you might not have access to enough data to determine the average lifespan length of your customers. But don’t worry—there’s a quick way to work around this and still get some actionable results from your calculations.
For newer stores, a lifespan of three years will work fine as a rough estimate. This will give you a good idea of how customers will potentially perform within the immediate future (as well as give you some added incentive to keep them around).
How to increase your customer lifetime value
While your calculations may have given you some results to get excited about, there’s always room for improvement! Here are some quick tips for getting the most out of every customer relationship by creating new opportunities to increase their value.
1. Start a loyalty program
More than 90% of companies have a customer loyalty program. They are one of the most effective ways to increase revenue and retain customers. More than 84% of consumers say they’d stick with a brand that offers a loyalty program, and 66% of them say earning rewards actually influences their spending behavior.
Use a loyalty program to show your most dedicated customers that you care by offering them gifts and rewards for repeat purchases. You can offer different perks to encourage upsells and cross-sells like:
- Gift cards
- Cash back
- Free swag
For example, bodycare retailer Blume used a point system called Blume Bucks (BBs) for its loyalty program, Blumetopia. Customers earn BBs by completing tasks like following the brand on Instagram, buying products, leaving a review, or having a birthday.
It’s free to join. And customers can redeem BBs for free products, merch, and other gifts from Blume.
Starting your loyalty program is easy. With an app like Smile, you can set up a program that gives your customers access to exclusive perks and discounts, referral and VIP programs, and other fun ways to engage with your brand when they log in to your store.
Learn more by reading Keep Them Coming Back: 7 Innovative Customer Loyalty Programs (And How to Start Yours).
2. Invest in customer experience
The pandemic forced brands across every industry to change their approach to customer experience. Almost immediately, ecommerce businesses responded by focusing on customer needs with shopping online and providing emotionally pleasing experiences.
Forrester’s 2020 CX Index revealed that customer experience leaders grow revenue faster, cut costs, and charge more for products.
Recent data from The XM Institute also shows that 95% of consumers that rate a company’s customer experience as “very good” are likely to recommend the company.
Some easy ways you can improve customer experience include:
- Being open to customer feedback and using that information to improve the experience
- Removing high-effort tasks like slow customer support and payments processing
- Thanking your customers by sending thank you notes, special gifts, and unexpected deals
- Creating a memorable unboxing experience that intrigues and delights customers
- Providing fast and easy support (Once a customer contacts you for help, the clock is ticking.)
- Measuring success and adapting (Use Net Promoter Score or customer satisfaction surveys to track customer sentiment. Higher scores mean your customer experience is good, while lower suggests your CX strategy isn’t working.)
Customer experience requires consistent nurturing and care. But with the right tactics, you can make a positive impact on your customer’s journey and realize higher sales and CLV.
3. Offer easy returns
You can’t avoid returns and refunds when running a business online. In 2020, consumers returned nearly $428 billion worth of products, just over 10% of total retail sales. Data suggests that 20% of online-bought products are returned, so you need to meet people in the middle.
If you get the returns experience right, 92% of customers will return to buy again.
If you want to improve your returns experience, an app like Returnly is a great option. It directly integrates with your Shopify orders and offers self-service returns for customers, like Outdoor Voices return portal below.
You can set your returns policy, control the branding, and automate the returns process. Returnly also has a Green Returns program that helps you reduce waste by deciding whether an item can be resold if returned, based on your return policy. If it can’t, customers don’t need to ship it back, which means less waste, cheaper shipping costs, and better customer experiences.
4. Upsell and cross sell
Upselling is a tactic to persuade customers to buy a premium or upgraded version of a purchased item or other items. The items are often more expensive, with the goal of making a larger sale. It’s used to sell to customers who’ve already made a purchase rather than selling to a new one.
Upsells work to increase CLV for two reasons:
- The probability of selling to an existing customer is 60% to 70%, compared to a 5% to 20% chance of selling to a new one.
- It increases average order value, which contributes to higher customer lifetime value.
Cross-selling is often confused with upselling. The key difference is that cross-selling involves a recommendation that complements the original product, while upselling is an upgraded version. Think of cross-selling as a server asking “Would you like fries with that?” and upselling as “Would you like Hendrick’s instead of well gin?”
Use an app like ReConvert to add upsell and cross-selling tactics to your store. It provides post-purchase funnels and one-click upsell pages you can design in minutes. You can also use it to display product recommendations, offer coupon codes, collect birthdays, and so much more.
5. Provide amazing customer service
Customer service helps customers out when something goes wrong. Support is an area of business normally associated with slow response times and inefficiency. Today, customer service needs to be amazing if you want to retain customers and encourage sales.
In fact, 36% of respondents to a US survey said “great customer service” is a motivation to recommend a brand online. Moreover, bad customer service is why 60% of Internet users hesitate when buying something online.
Research what channels your customers prefer for support. Do they prefer self-service? Social media? Or website live chat? Once you know which channels to focus on, you can invest in them and provide better support.
Shopify Inbox is a free Shopify app that helps retailers provide omnichannel support for customers. You can talk with and sell over online store chat, social media, and email, all from the app. You can also send products, discounts, and new orders from your Shopify store directly inside chats with just a few taps to turn more conversations into checkouts.
Shopify Inbox also connects with popular message platforms like Facebook Messenger so customers can contact you directly from your Facebook page, Facebook shop, and Messenger.
6. Use email marketing
Customer lifetime value consists of many moving pieces and channels, but overall it boils down to one goal: increase engagement and improve customer relationships. Email works in two ways to improve customer lifetime value: fast, asynchronous support and encouraging repeat purchases from customers.
Email lets you keep customers in the loop on product restocks, upcoming sales, and exclusive deals with a well-curated, beautifully designed newsletter. Other ways to lean on email to encourage sales and reduce churn rate are:
- Sending thank you and appreciation emails post-purchase
- Targeting campaigns based on past interaction and purchases with your brand
- Nonpayment and dunning emails that resolve failed payments
- Providing useful resources
- Sending winback emails after periods of inactivity
“When we work with clients to increase their CLV, we always focus on two things,” says Danavir Sarria, founder of email marketing agency SupplyDrop. “First, we identify offers that encourage repeat purchases. Second, we align their email marketing calendars to fit with how their customers like to buy.”
Danavir adds, “For example, if you sell body wash, the best thing you can do is come up with a strong subscription offer and schedule of new products you’ll be launching. By doing this, you give customers a strong reason why they should buy more from you.”
From there, Danavir and his team plan to send email campaigns during busy shopping seasons, like the winter holidays and back-to-school season. They also send emails for branded holidays and product launches to keep customers active and engaged.
If we can have one big [email] campaign every one to two months, CLV will naturally go up.
Use Shopify Email to create, send, and track your email campaigns. With this free Shopify app, you can:
- Send branded emails to your subscribers in just a few clicks, right from your Shopify admin
- Choose from a growing collection of email marketing templates like product collections, sales, restock, newsletters, holidays, events, and more
- Personalize your subject line, preview, and body text with customers’ information for a more engaging experience
- Segment emails to ensure the right message gets to the right person
- Track results, including open and click-through rates, products added to carts, and purchases
Learn more about using email in your store by reading Learn Email Marketing: Everything from List Building to Advanced Lifecycle Automation.
7. Be active on social media
Platforms like Facebook, Instagram, and TikTok are perfect for reaching out to and connecting with your audience. It helps customers understand your brand and its values. Social media is also used as a support channel, even more so as we move toward social commerce.
Nearly 19% of social buyers completed their most recent purchases without leaving the social app. Seventy percent surveyed expect to message businesses more in the future with customer service questions. When people buy directly on social media, they likely won’t seek customer care elsewhere. They want to message you in-app.
Stay at the top of your customers’ minds with an engaging and fun social media presence. Also prepare your team to actively provide support on social media to create a great customer experience and increase customer lifetime value.
- Go Beyond Likes and Follows: How to Create a Social Media Strategy That Sells
- How to Make Money on TikTok: 8 Ideas for Monetization
- Getting Started on IG: A Beginner’s Guide to Instagram Marketing
8. Start a subscription service
Do you offer a product that customers need to buy regularly, like coffee beans or socks? Think about setting up a subscription program to lock in repeat business.
Customers love convenience, with research showing that 15 percent of online shoppers have signed up for one or more subscription services to receive recurring products. The subscription ecommerce market is growing rapidly and is expected to reach $478.2 billion by 2025.
Overall, a subscription box helps turn one-time shoppers into repeat customers. It also provides predictable monthly revenue, more cash on hand, and reduces customer acquisition costs.
Want to create your own subscription box? Read How to Start a Subscription Business: A Brief Guide.
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Putting your CLV to work
With your customer lifetime value in hand, you’ll now be able to start building smarter, more efficient campaigns by optimizing your spending and fine-tuning your targeting.
One of the primary uses for CLV is to help you keep your cost per acquisition as low as possible.
If you don’t know how much you’re spending to acquire new customers, all you need to do is divide your total marketing/sales budget for a specific time frame by the amount of new customers you gained in that same time frame. The resulting number will be the average amount that you spend every time your business acquires a new customer.
The difference between your customer lifetime value and your cost per acquisition is your return on investment, or ROI. That’s the amount of money you get out of a customer relationship after you’ve deducted the money that you spent to kickstart the relationship in the first place. To stay profitable, you’ll need to maximize your ROI.
Additionally, if you know your CLV, you’ll also be able to figure out how much you can afford to spend on paid ad campaigns on Google and Facebook.
To determine how much you should be putting into campaigns, you’ll first need to know your conversion rate.
For instance, if your customer lifetime value is $100 and the conversion rate for one of your marketing campaigns is 10%, then your maximum bid for that campaign should be 10% of $100. So, in this scenario, you’d be able to bid a maximum of $10 per click without blowing your budget.
Find the right customers for your business
Success isn’t about finding customers—it’s about finding the right customers. Now that you can calculate the lifetime value of your current customer base, you’ll be able to start crafting campaigns that target and win over those customers that really make the difference for your bottom line.