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, 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 the Customer Lifetime Value? and what is its meaning?

The CLV that 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 you invest but throughout your employment relationship.

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

Why is CLV important?

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

Acquire new customers.
Retain existing ones with benefits.

This metric is used when you have a relationship of several years with a customer, taking into account this value helps to understand the consumer experience and measure feedback at all key touch points , in order to interpret what are the drivers of the customer. CLV .

Remember that the contact points are defined as:

“Moments in which 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 experience”.

Said 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 revenue.

Do you know how much your clients are costing you?

The CLV is related to several important metrics, which we will review in detail below:

CAC: Customer Acquisition Cost.

The cost of customer acquisition is equal to the money that is invested to attract a new customer , it includes factors such as:

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

Example: If the CLV of an average marketing agency client is $60,000 per month and it costs more than $60,000 to acquire through the above factors, the marketing agency could be losing money unless it lowers 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 your physical location, contact center costs, etc.

Breaking down the cost of service per customer helps you understand costs at a granular level and drill down into details like whether high customers cost the same as low ones and whether some customers are more expensive than others.

The cost of servicing varies over the lifetime of the customer, unlike customer acquisition, which is a one-time expense. To re-obtain service, your cost may be high during the first year of a contract, but will gradually decrease as the customer stays with you. So, if your renewal rates drop, your average cost of service is likely to increase, causing a drop in profitability.

How is customer lifetime value measured?

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

"You have bought a rate plan of $600 pesos per month for 3 years, your CLV has been $7,200.00" It was easy, 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 the data from all areas of an organization are integrated, it is easier to calculate it, which is why we recommend doing it.

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

Value touch points
Customer Journey Records
Touchpoint revenue
Add actions throughout the life of that customer

The customer journey is created from a consumer 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 you understand the steps customers take when they interact with your business.

Customer Lifetime Value Formula

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

Other metrics that help to obtain the 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 future loyalty promise .

By calculating CLV, you'll know how much customer experience is worth investing in for a positive ROI . This will help you build 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?

The CLV can be calculated:

Average of all customers
Customer segment level (i.e. if they are categorized)
individual level.

To start 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 the average purchase value.
Average Customer Lifetime : The average length of time a customer continues to buy .

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 that the customer spends with the company during its lifetime.

But what happens when your customer revenues are n't holding steady and you need to account for changes that occur throughout the customer's lifetime?

If this is the case, a more detailed formula will be needed. Therefore, we recommend using the traditional customer lifetime value formula 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 (that is, revenue minus your 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 leave during that time)

D: Discount rate

A percentage of inflation . This is frequently set to 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 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 perform:

Investment tracking emphasizing customer experience
Identify new opportunities to design experiences that deliver results.
Optimize marketing spend by prioritizing your customer acquisition strategies, making sure to spend your budget in areas that attract new customers.
Reduce churn and drive loyalty to identify 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 biggest impact on the bottom line.
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 of them.

In conclusion, the CLV is important to deepen and identify the factors why the client decides to retain or withdraw their employment relationship based on income or other actions.