Customer lifetime value: how to calculate it and integrate it into a strategy?
In order to answer this question, first of all we must know what the meaning of this metric or KPI is, what it measures and what its value is; In this article you will know the answer to these unknowns...
What is Customer Lifetime Value? and what is its meaning?
CLV, which stands for " Customer Lifetime Value" or in other words "customer lifetime value" is a key statistic to track your experience. That is, it measures how valuable a client is to your company , not only in what they invest but throughout their employment relationship.
Customer lifetime value is an important metric because it costs less to maintain existing customers than to acquire new ones . Therefore, increasing the value of existing customers is vital to driving company growth.
Why is CLV important?
As we had mentioned before, knowing the CLV helps companies develop strategies to:
- Acquire new clients.
- 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 at all key touchpoints , in order to interpret what the drivers of the customer are. CLV .
Let us remember that the 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 wear and tear 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 is related to several important metrics, which we will review in detail below:
CAC: Customer Acquisition Cost.
The cost of customer acquisition is equivalent to the money invested to attract a new customer , it includes factors such as:
- a) Advertising
- b) Marketing
- c) Special offers, etc.
Example: If the CLV of a marketing agency's average client is $60,000 per month and it costs more than $60,000 to acquire them through the aforementioned factors, the marketing agency could be losing money unless it reduces its acquisition costs. . Another thing to consider is the cost of that customer to your business.
CS: Cost of Service
The cost of service involves everything that is done to get the product or service into the hands of the customer. This metric is influenced by aspects such as: logistics, general expenses in its physical location, contact center costs, etc.
Breaking down the cost of service by customer helps you understand costs at a granular level and drill down into details such as whether high customers cost the same as low customers and whether some customers are more expensive than others.
The cost of service varies throughout the customer's life, unlike customer acquisition, which is a one-time expense. Getting back into service may cost you a lot 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 of service is likely to increase and cause a drop in profitability.
How do you measure customer lifetime value?
The easiest 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” It was simple, right? However, in larger companies with more complex products and business models, CLV becomes more complicated to calculate.
Some companies do not 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 is easier to calculate it, which is why we recommend doing it.
CLV can be measured by taking the following steps into account:
- Value touchpoints
- Customer journey records
- Touchpoint revenue
- Add actions throughout the life of that client
The customer journey is created from a consumer journey map, this map is the process of forming a visual representation of customers' needs and perceptions throughout their interactions and relationships with an organization. This helps you understand the steps customers take when interacting with your company.
Formula to obtain customer lifetime value
There are valuable formulas that can help calculate CLV and identify different ways to increase revenue .
Other metrics that help 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 it may be an early sign of wear.
What is needed to calculate it?
CLV can be calculated:
- Average of all clients
- Customer segment level (i.e. whether they are categorized)
- Individual level.
To begin you need the following information:
- 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 but now it will be 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 period 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 the customer spends with the company over their lifetime.
But what happens when your customers' income isn't staying stable and you need to account for changes that occur throughout the customer's life?
If this is the case, a more detailed formula will be needed. Therefore, we recommend using the traditional customer lifetime value formula; it 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 customer's average lifetime (i.e., revenue minus its costs).
A: Retention rate
It is the percentage of loyal customers who stay with you for a given period of time (as opposed to those who churn during that time)
D: Discount rate
A percentage of inflation . This is frequently set at 10%.
Let's take a look at this customer lifetime value calculation in action...
- Your company's GML = $2,200
- Your customer retention rate = 70%
- 10% discount rate
So:
(1+ D – R) or;
(1+0.1-0.70) = 0.4
GML * R is equivalent to;
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 do:
- 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 on areas of attracting new customers.
- Reduce churn and drive loyalty by identifying high-value customers you want to nurture and reward long before they reach 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 greatest impact on the final result.
- Design new experiences to grow the business. See the correlation between customers who have engaged with a particular touchpoint, such as purchasing through a specific channel, or improving a product's features through reviews.
In conclusion, the CLV is important to delve deeper and identify the factors why the client decides to retain or withdraw their employment relationship based on income or other actions.