As a business owner, there are dozens of important metrics you need to both track and understand.
From your net profit margin to sales revenue and retention, these critical metrics help you stay on track as you grow and scale your business. Not tracking the right metrics is a dangerous road to walk, as it can lead you to some unsuspected surprises throughout your business journey.
One of the most important metrics you’ll want to pay particular attention to relates to your customer lifetime value. This metric tells you what you can expect from an average customer over the course of your business relationship.
In this guide, we’ll walk you through exactly what customer lifetime value is and why it’s important.
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What is customer lifetime value?
Customer lifetime value (CLV or CLTV) is a metric that represents the total net profit a company can expect to generate from a customer throughout their entire relationship. It takes into account the customer’s initial purchase, repeat purchases, and the average duration of their relationship with the company.
Customer lifetime value helps you understand and gauge current customer loyalty. If customers continue to purchase from you time and time again, that’s usually a good sign you’re doing the right things in your business. Furthermore, the larger a customer lifetime value, the less you need to spend on your customer acquisition costs.
Let’s look at an example.
The CLV of a Honda owner might be as much as $100,000 if they are happy with their car or minivan choice and end up buying several through the years. Or the CLV of a regular coffee drinker might be even higher than that, depending on how many cups of coffee they drink a day and where they buy it. Conversely, someone who buys a home twice in their life might be worth only, say, $15,000 to a real estate agent, because while the value of the purchase is huge, the percentage paid to an agent is only a fraction of the total.
In the big picture, customer lifetime value is a gauge of the profit associated with a particular customer relationship, which should guide how much you’re willing to invest to maintain that relationship. That is, if you estimate one customer’s CLV to be $500, you wouldn’t spend more than that to try and keep the relationship. It just wouldn’t be profitable for you.
If you understand your CLV well, that can help shape your business strategy to keep existing customers, rather than investing the resources in acquiring new ones. Of course, new and current customers play an important role in business building in general.
Why is customer lifetime value important?
Understanding CLV allows you to make informed decisions based on how long a customer typically buys from you and what they spend over the lifetime of that relationship. This metric can help inform your strategy on acquisition, customer retention, customer support, and even the quality of your products and services.
Calculating customer lifetime value for different customer segments helps in a number of ways, mainly regarding business decision making. Knowing your CLV can tell you, among other things:
- How much you can spend to acquire new customers (CAC) and still have a profitable relationship
- The exact amount you can expect an average customer to spend over time
- What kinds of products high-value customers want
- Which products have the highest profitability
- Which customer relationships are driving the bulk of your sales
- Who your most profitable types of clients are
- Details about the customer journey and churn rates
Using your CLV as a base, you can work to better understand your most loyal customers. What do they like? Why do they continue to purchase from you?
Together, these types of decisions can significantly boost your business’s profitability.
As with any metric you track in business, knowing the number is not enough. You have to use your CLV to shape your overall business strategy.
- If your customer lifetime value is on the rise, that could mean you should continue to invest in product development or your customer success teams.
- If your CLV is declining, that might tell you your latest marketing strategy could use a reboot.
One of the main benefits of understanding CLV is that it can help you significantly reduce your customer acquisition costs over time.
Ways to improve CLV
Here are some proven techniques to improve the customer experience and bottom line:
- Make it easy for customers to return items they’ve purchased from you. Making it hard or expensive will lower customer satisfaction and reduce the odds of them making another purchase.
- Make strategic exceptions for your most loyal customers. For example, if someone is planning on canceling a subscription service you offer, give them an option of remaining a user with a small discount.
- Interview and connect with your best customers to understand why they continue to choose your brand.
- Set expectations regarding delivery dates, aiming to underpromise and overdeliver. It’s much better to promise delivery by August 1 and have it in their hands by July 20 than the reverse.
- Create a loyalty program. Encourage repeat purchases with rewards that are both attainable and desirable.
- Reward loyal customers. Offer freebies for doing business with you to build brand loyalty.
- Run deals exclusive to existing customers.
- Use upsells to increase the average value of a customer transaction, which is the equivalent of McDonald’s asking, “Would you like fries with that?”
- Stay in touch. Long-time customers want to know you haven’t forgotten them. Make it easy for them to reach out to you as well.
Using CLV to shape your business strategy you’ll ultimately build a more profitable, successful business by focusing on attracting and retaining long-term customers who will become advocates for you, as well as repeat buyers.
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Customer lifetime value FAQ
What are the three parts of customer lifetime value?
To calculate customer lifetime value, you need to know:
- The average purchase a customer makes
- The average rate in which a customer makes a purchase
- How long a customer typically remains loyal to your brand
What is the customer lifetime value formula?
While the formula can be a little more complex if needed, the most basic customer lifetime value calculation is as follows: Average Order Value x Purchase Frequency x Average Customer Lifespan (LTV).
What is an example of customer lifetime value?
Say you’re an ecommerce clothing brand. If an average customer purchases $200 worth of products three times a year and remains a customer for five years, the CLV of that customer would be $3,000 ($200 x 3 purchases x 5 years).
How can you increase customer lifetime value?
To increase customer lifetime value, you can offer personalized shopping experiences, recommend products based on browsing or purchasing history, and offer loyalty rewards or exclusive discounts to repeat customers. Regularly engaging with customers through email marketing and social media can also help to foster long-term relationships.