John and Amanda are two customers of an online food takeaway business. They both spend a high amount of their money on ordering from the app and are considered by the company to be loyal customers. But who provides the most value to the company? There has to be a measure that can help the company determine both individuals' values. Right?
Well, the short answer is: Yes. Companies do know how to measure the value of their customers, and they do so by calculating each customer's lifetime value.
Customer lifetime value (CLTV) can provide the necessary data to the company about customers who are spending more and long periods. This data helps companies to make decisions about whether or not to acquire new customers or retain existing ones.
Measuring CLTV can help you learn how well your customers like your product, what you should do to earn their loyalty, and how you should budget for your customer retention campaigns.
This blog will discuss in depth how to calculate customer lifetime value and how it can be improved to acquire new customers and retain old ones.
Customer lifetime value (CLTV) is a measure of the total worth of a customer to a business over the entirety of their relationship with the company. As it is less costly to retain existing customers than to bring in new ones, companies need to know it's customers' liftime values as it can help them gauge which customers to retain and which to let go of.
Let’s say John orders food from the takeaway business for one year. On the other hand, Amanda orders food from them for two years. So, the lifetime of both John and Amanda are one and two years, respectively, and their CLTV will be the amount the company expects to make within their lifetimes as their customers.
CLTV can be influenced by customer support and success teams. Customer success managers can resolve issues and pain points along the customer journey and help them to increase customer loyalty and reduce churn rate.
Calculating the customer lifetime value can be extremely beneficial in making business decisions. For example, you can use CLTV to identify customer segments that are more valuable to your business and target them accordingly.
Let’s examine why customer lifetime value is an important metric for businesses to calculate.
CLTV can provide product marketers with the target at whom they can focus their efforts to increase revenue. Marketers can use email automation to send targeted emails to these customers announcing the new features of their products, reduced prices announcements, or discounts offerings. Thus, your plan should encourage customers to spend more for a long time. It will increase the CLV, which will translate into higher profits.
Customer attrition or churn is one of the biggest challenges faced by marketers. The churn rate is inevitable, and every product marketer has to suffer at its hand. Thankfully, CLTV helps in retaining customers and boosting loyalty.
Customer lifetime value can tell you what might be wrong with your marketing strategy. You can work to better your customer support strategy or start loyalty programs to meet your customers' needs better.
Acquisition of new customers is five times more costly than retaining customers. Also, according to a study conducted by Bain & Company, an increase of a 5% retention rate can increase profits between 25% to 95%.
Hence, these findings show that nurturing and retaining customers can lead to increased profits, reduced customer acquisition costs, and increased customer lifetime value.
Calculating CLTV can help you identify the ideal target customers to retain. When you know the CLV of your customers, you know how much money they have spent with your business over time. Armed with this knowledge, you can devise a customer retention strategy for those customers that spend the most money on your business.
CLTV helps in sales forecasting. With the historical data of customers available, you can predict how much customers will spend on your products in a quarter or a year and thus, canhelp you predict the number of sales you will have.
As there are benefits to measuring CLTV, also, there are some challenges that come with measuring CLTV. Here are some of them:
CLTV can be a tough metric to calculate if you don’t have an Enterprise Resource Planning (ERP) system or a Customer Relationship Management (CRM) system in place. The availability of these systems can make this information easily available.
Only looking at a company's overall CLTV can be misleading as it covers up many problems in customer segments. You should break down the data into customer size, location, and other segments to get a better understanding.
Customer lifetime value can be calculated at the organization level, customer segment level, or individual customer level. To calculate CLTV at all these levels, you need the following values:
It is the value of customer purchases over a specific period of time, divided by the number of purchases in that period.
It is the number of purchases in a specific period of time (usually a year), divided by the number of individual customers who made a transaction during the same period.
You get customer value by multiplying the average purchase frequency by the average purchase value.
It is the average length of time that a customer continues to do business with a company.
Now that you know why customer lifetime value is important, it is time for you to know the various ways you can calculate customer lifetime value.
Historically, the calculation of customer lifetime value has been straightforward. The Average Revenue Per User (APRU) has been the approach followed to calculate the customer lifetime value, by taking into account the gross revenue customers bring in. This calculation is easy as you only need data on previous purchases made by the customer.
Thus, the formula for calculating CLTV is:
Let’s illustrate this with an example. Suppose 30 of your customers bring in $20,000 in revenue in three months. So, your APRU for three months comes out to be: $20,000/30 = $666 per customer.
Now, lets calculate how much revenue these customers will bring in an year.
ARPU for 12 months = $666*4 = $2664 per customer.
ARPU method works by taking into account all the customers with similar characteristics and grouping them together. It is therefore an ideal method to calculate CLTV of customers with similar purchase patterns, and can also help in creating the forecast you are trying to create. However, it’s also its limitation.
ARPU combines the new customers who have different purchasing habits with the already existing customers, which can then give inaccurate results. This can be a problem if you are changing your marketing strategy to bring in new customers. Therefore, we use the predictive approach to forecast future sales.
Predictive CLTV is used to determine the value of a customer over a specific period of time. The predictive approach is based on both historical data and current customer behavior, such as purchase frequency. Unlike historical CLTV, predictive CLTV helps businesses to ascertain the current value of customer and how this value will change in the future.
This can help you in launching targeted campaigns and prioritize your acquisition and engagement activities so that they attract new customers and retain existing ones with high lifetime values.
The predictive CLTV formula is:
T: Average number of transactions per month
AOV: Average order value
AGM: Average gross margin
ACL: Average customer lifetime
The growth of a business is anything but smooth. It so happens that your sales per customer don’t remain the same year per year. Therefore, you need a more in-depth CLTV formula that takes profit margins, inflation, and customer retention rate into account. So, the traditional CLTV formula is:
GML is the gross margin contribution per customer lifespan which is the profit a business expects to make over the average customer lifetime. It is calculated as:
R is the retention rate of the customer who stick with a business over a specific period of time. It is calculated as:
D is the discount rate which is included to account for inflation. A 10% discount rate is used for SaaS businesses.
Companies can adopt a number of strategies to boost their customer lifetime value. Here are seven tips to improve your customer lifetime value.
Improving customer experience is a critical step in improving customer lifetime value. Make sure that you improve all the touch points of your business such as in-app experience and customer support. If customers have a hassle-free experience then they are more likely to come back for repeat business.
Feedback emails are a great way to gather feedback from customers about all their pain points. You can use email automation to send feedback emails every time a customer makes a purchase.
Take a look at what Withings, a consumer electronics company, does to improve their customers’ experience. They send emails asking for their customer’s feedback on how to improve their services. The email copy is simple and to the point and directs the reader to the CTA “Start The Survey.”
An onboarding process full of hassles can turn away new customers. Therefore, it is essential that your onboarding process is streamlined and doesn’t have any hurdles for your customers.
You can create automated onboarding flows to ensure that your customers are guided through every step of their onboarding process. Guide them thoroughly through each step of the onboarding process.
Pitch does a great job of onboarding its new users. Its onboarding email details all the ways the user have at their disposal to create highly effective presentations.
Loyalty programs are extremely helpful in increasing a customer’s average purchase frequency. They keep buyers engaged and reward frequent purchases. Moreover, initiating loyalty programs can help create brand loyalists who will help drive word-of-mouth marketing.
Building brand loyalty is also important as it can reduce the churn rate and increase customer retention rates. Moreover, companies that do have loyal customers have higher than normal customer lifetime values.
You can send automated loyalty program emails to customers with higher than average lifetime value.
Have a look at how Foxtrot offers its customers a loyalty program. Customers can earn points when they shop online or in-shop and pay with the app. The perks customers can enjoy are free deliveries, all-day happy hour, and free gift wrapping.
Having a robust and dedicated customer service in place can help increase customer loyalty. 90% of Americans say that customer service is among the factors they consider when choosing to do business with a company.
You can improve your customer service by improving your omnichannel support, providing personalized offers, and implementing a proper refund policy.
Another tip to improve your customer lifetime value is to send out targeted content to your customers. By sending out personalized emails to your customers that contain discounts, offers, and other perks, you can ensure that your customers always remain engaged with your emails, and by extension, with your company.
Also, you can leverage content marketing by offering eBooks, podcasts, and webinars to entertain and educate your customers about your product.
Make use of the data your customers provide upon onboarding, or send out detailed survey forms that contain questions that you want to ask your customers.
Customers who have spent a lot of money, and have stuck with your brand for a long time, should be offered strategic discounts every once in a while. This is where customer lifetime value comes into play.
Use CLTV of customers to recognize your best customers and then send them targeted emails to reward their trust in your company.
Your CLTV doesn’t only depend on your best customers. Rather, the customers who are unhappy with your company should be reached out and brought back into the fold once more.
You can use your customer support to reach out to them and get their feedback on all the pain points. Then resolve all the issues that your customers face and provide them with something exclusive, like a well-back discount or a free eBook.
The calculation of customer lifetime value may be a time-consuming process, but the pros immensely outweigh the cons. CLTV not only helps you to identify valuable customers but also helps you in tweaking your marketing strategies to better suit the needs of your customers.
By using the tips mentioned in this blog, you can boost your customer lifetime value and increase your company’s profitability.
Content writer by day and a book nerd by night, Ammar Mazhar has been writing for 3 years for B2B and B2C businesses. As a wordsmith, Ammar knows how to write SEO-optimized content that your users will find insightful, igniting results for your business.