Customer Lifetime Value – What is it & How to Calculate

Customer Lifetime Value – What is it & How to Calculate

Welcome to Math class. No, we’re just kidding (not kidding).

Let us start by saying that all customers are equally important. However, some are more valuable than others.

It’s a fact that your customer is the most important thing to the success of your company. Without purchasing/paying customers, your business will unfortunately not survive. Yes, of course, profit, revenue, and sales are of massive importance, but there are also underlying areas that can be improved upon that have a direct impact on your bottom line. We’re here to tell you what CLV is and why it is vital for your business’s present and future success.

As you can see from the title, CLV stands for Customer Lifetime Value. It is a calculation made up of a bunch of things that will allow you to see a better and fuller picture of your businesses.

CLV will be able to tell you how much value each of your customers give you over their customer lifetime period with you.

Why is this important?

Well, for starters, part of the calculation includes needing to work out the average spend of each of your clients. Useful to set up a rough prognosis for future sales. Secondly, as you get on to the CLV, you’ll be able to understand the value each of your clients brings to you, which allows you to work out how much you should be spending on attaining and acquiring them.

Hold on, we’re getting ahead of ourselves. There is actually quite a regimented and straight-forward procedure to getting to the bottom of this, so let’s follow it, shall we?

Small disclaimer. Customer behaviors are very difficult to track in general, which is what we’re attempting in part here, so bear with us. There are a lot more complex ways of working this out, with Oxford University style algorithms and Cambridge University type predictions. We don’t (and you probably also don’t) have the time for intricacies now. Right now, you most likely just need a solid estimate so that you can continue with your workday with a bit more insight and knowledge in your back pocket.

Even with a ‘simplified version’ you will still be able to get a reliable overview of your customer's spending patterns, which is information that you will be able to analyze, understand and then turn into your benefit. We get it, we’re here for you, and we’re about to get into just how you do this.

*bell rings, class has begun*

Calculation Time

We first need to calculate the Average Order Value. This tells you how much each of your customers spend on average with you. This is easy to calculate. You take your total sales and divide it by your total number of orders. Don’t forget to always use the same time frame, so let’s use 12 months for the sake of these examples.

Right, so work that out and jot that number down somewhere on your notepad. (Many E-Commerce platforms have this number readily available on their analytics dashboard, so this should be easy as pie.)

Next thing we need to do is calculate the Purchase Frequency. This will tell you the average number of orders placed by each customer. This you calculate by taking your total number of orders (over the same time period, so 12 months here in our example) and dividing this by the total number of customers.

One more calculation before we hit the big one. We now need to determine the Customer Value. This is a monetary amount. It represents the average monetary value that each customer brings to your business over a specific time frame. This is why you needed the above two figures. You now need to multiply the Average Order Value by the Purchase Frequency.

Now we are finally bringing it home. Last calculation, the big one, are you ready?

Customer Lifetime Value

This you calculate by multiplying the customer value by the average customer lifespan.

Oh goodness, where did this customer lifespan come from? And surely, it’s completely different for businesses that are new vs businesses that have been around for a while? Yes, lifespans differ hugely for different verticals.

We would recommend taking a conservative approach, by looking at your existing customers and taking the average timespan between their first and last order with your company.

Now let’s look at the final formula:

So, the CLV = customer value x customer lifespan

Why You Should Do All The Math!

Working out your CLV will open your eyes on understanding the value of your customers and gives you the means to improve upon your revenue and profit without having to akquire new customers. For example, you could implement some marketing strategies to increase the average purchase amount, or work on a way of increasing the purchasing frequency. Another idea is trying to get your customers to stay with your business for a longer period of time.

The clever thing about CLV is that it gives you an informed look into your clients and which ones and where you should be targeting your marketing to. You want to avoid marketing blindly, so you can use CLV to help you focus your attention on where you should be marketing and to whom.

Simply take a look at clients that have an above-average CLV and compare them to clients that are below-average on this KPI. If you can make out patterns, you can start working on these customers. For example, you could give these customers perks, or try to get the attention of customers that are not as frequent in a more targeted way, as you will then know exactly who you are speaking to.

A higher CLV also opens up possibilities when acquiring new customers, as you can spend more on marketing to get a single new customer, when you know they also spend more over their lifetime with you. This is a massive benefit, as we all know that E-Commerce marketing channels like Google and Social Media ads are skyrocketing in cost.

Well, there you have it. That’s how you get down to the bottom of it, and we worked that out just in the knick of time, as I believe that the bell is about to…

*RING*

Conclusion

Not as tricky to work out as you imagined, right? With this simplified approach, you can work out your CLV and incorporate this information in your business to create more sales.

Keep your eyes peeled for blogs we will be posting about the benefits that working out the CLV will bring you and also how to increase your CLV! Exciting times and blogs ahead. Be sure to sign up for our newsletter so that you don’t miss any of these posts!

If you have any questions about this, feel free to pop us an email on hello@especial.digital or contact us on our website.