Customer lifetime value: how to calculate it and integrate it into a strategy?

by Gerardo Sánchez August 13, 2022

In order to answer this question, we must first know what the meaning of this metric or KPI is, what it measures and what its value is. In this article, you will learn the answer to these questions…

What is Customer Lifetime Value? and what does it mean?

CLV, which stands for Customer Lifetime Value, is a key statistic for tracking your customer experience. In other words, it measures how valuable a customer is to your company , not only in terms of your investment but throughout their working relationship.

Customer lifetime value is an important metric because it costs less to retain existing customers than to acquire new ones . Therefore, increasing the value of existing customers is vital to driving business growth.

Why is CLV important?

As we mentioned before, knowing the CLV helps companies develop strategies for:

Acquire new customers.
Retain existing ones with benefits.

This metric is used when you have a multi-year relationship with a customer. Taking this value into account helps you understand the consumer experience and measure feedback across all key touchpoints , in order to interpret the drivers of CLV .

Let us remember that contact points are defined as:

“Moments when a customer comes into contact with your brand. These points make up the customer’s journey to acquire the service or product and are key to influencing the customer’s experience.”

This customer journey helps us detect the first signs of attrition to counteract them and improve their loyalty , so that they in turn recommend us to others and increase the company's income.

Do you know how much your clients are costing you?

CLV relates to several important metrics, which we will review in detail below:

CAC: Customer Acquisition Cost.

Customer acquisition cost is the amount of money invested to attract a new customer , and includes factors such as:

a) Advertising
b) Marketing
c) Special offers, etc.

Example: If a marketing agency’s average client CLV is $60,000 per month and it costs more than $60,000 to acquire them through the factors mentioned above, the marketing agency could be losing money unless it reduces its acquisition costs. Another thing to consider is the cost of that client to your business.

CS: Cost of Service

Cost to serve involves everything that is done to bring the product or service into the hands of the customer. This metric is influenced by factors such as logistics, general expenses at the physical location, contact center costs, etc.

Breaking down cost to serve by customer helps you understand costs at a granular level and drill down into details like whether high-end customers cost the same as low-end customers and whether some customers are more expensive than others.

The cost to serve varies over the life of the customer, unlike customer acquisition, which is a one-time expense. To get back to service, your cost may be high during the first year of a contract, but it will gradually decrease as the customer stays with you. Therefore, if your renewal rates fall, your average cost to serve is likely to increase, leading to a drop in profitability.

How do you measure customer lifetime value?

The simplest way to calculate it is with the following example:

“You have purchased a rate plan of $600 pesos per month for 3 years, your CLV has been $7,200.00” That was easy, right? However, in larger companies with more complex products and business models, the CLV becomes more complicated to calculate.

Some companies don't measure customer lifetime value, citing the challenges of segregated teams, inadequate systems and untargeted marketing. But when data from all areas of an organization is integrated, it becomes easier to calculate, so we recommend doing it.

CLV can be measured by taking into account the following steps:

Value touchpoints
Customer journey logs
Revenue from touchpoints
Add actions throughout the life of that client

Customer journey is created from a customer journey map, this map is the process of forming a visual representation of the needs and perceptions of customers throughout their interactions and relationships with an organization. This helps in understanding the steps that customers take when interacting with your company.

Formula for obtaining customer lifetime value

There are valuable formulas that can help you calculate CLV and identify different ways to increase revenue .

Other metrics that help to obtain CLV:

CX: Customer Experience

NPS: Net Promoter Score

CSAT: Customer Satisfaction

In short, CLV measures a tangible impact on revenue , while NPS and CSAT measure a future promise of loyalty .

By calculating CLV, you will know how much it is worth investing in customer experience to have a positive ROI . This will help you create customer loyalty prediction models . If the CLV represents a drop in customer loyalty, it may be an early sign of attrition.

What does it take to calculate it?

CLV can be calculated:

Average of all customers
Customer segment level (i.e. whether they are categorized)
Individual level.

To begin, the following information is needed:

Average Purchase Value: Value of customer purchases over a period of time, divided by the number of purchases in that period.
Average Purchase Frequency: Divide the number of purchases in that same time period by the number of individual customers who made a transaction during the same period.
Customer Value: Average purchase frequency multiplied by average purchase value.
Average Customer Lifetime : Average length of time a customer continues to purchase .

The formula is:

CLV = Customer Value X Average Customer Lifetime

The resulting CLV is a monetary value (depending on your currency) and shows the average amount that the customer spends with the company during their lifetime.

But what happens when your customers’ revenue is n’t stable and you need to account for changes that occur throughout the customer’s lifespan?

If this is the case, a more detailed formula will be needed. That's why we recommend using the traditional customer lifetime value formula that fits the bill for many companies in this position.

Traditional CLV formula

GML * R / (1+ D – R) = CLV

Where:

GML: Gross margin per customer lifetime

This is the expected profit over the average customer's lifetime (i.e. revenue minus costs).

A: Retention rate

It is the percentage of loyal customers who stay with you over a given period of time (as opposed to those who churn during that time)

D: Discount rate

A percentage of inflation . This is often set at 10%.

Let’s take a look at this customer lifetime value calculation in action…

GML of your company = $ 2,200
Your customer retention rate = 70%
10% discount rate

So:

(1+ D – R) or;

(1+0.1-0.70) = 0.4

GML * R equals;

2,200 * 0.70 = 1,540

Finally divide the results of the GML * R / (1+ D – R)

1,540/0.4= 3850

Therefore the CLV is equal to $3,850.00

CLV= 3,850

How to use CLV calculations in a strategy?

By obtaining the CLV you can:

Investment tracking emphasizing customer experience
Identify new opportunities to design experiences that deliver results.
Optimize marketing expenses by prioritizing your customer acquisition strategies, making sure to spend the budget in areas that attract new customers.
Reduce churn and drive loyalty by identifying high-value customers you want to nurture and reward long before they show signs of attrition like reaching out to customer service or threatening to cancel.
Identify costly experience gaps. With CLV, you can see which touchpoints in the journey have the biggest impact on the bottom line.
Design new experiences to grow your business. See the correlation between customers who have engaged with a particular touchpoint, such as purchasing through a specific channel, or improving product features through reviews you create for them.

In conclusion, CLV is important to further understand and identify the factors that explain why customers decide to retain or withdraw their employment relationship based on income or other actions.