Understanding Customer Lifetime Value (CLV)
What is the customer lifetime value?
Customer lifetime value as the name suggests is the measure of the total value that an ecommerce business has earned from a particular customer over a period of time. CLV as a metric provides a bigger picture for the business’s future growth and financial visibility.
Importance of customer lifetime value
Customer lifetime value (CLV) can prove to be extremely beneficial for your business in many ways. Below mentioned are a few ways in which calculating your customer lifetime value can be helpful for your business.
- Tracking your customer details and calculating your customer lifetime value gives you a detailed picture of which segment of customers is driving more consistent revenue to your business. This will help you know what is working for which customer segment and will be extremely beneficial in planning for customer retention.
- Tracking customer details and calculating customer lifetime value also helps us in understanding the future prospects of our business by giving us a detailed overview of possible opportunities that can arise or any threat that might come in the future.
- Tracking customer details and calculating customer lifetime value also helps in the business’s cost management. One can spend on advertising for different customer segments in different ways and extents. Not only this but by knowing the future prospect of business one can also keep a check on the number of staff, production capacity and other costs.
A higher customer lifetime value is a good indicator of increased profitability as a higher CLV implies that the business is retaining more and more customers that are willing to spend money on the product or service and will remain loyal to the business.
Customer lifetime value calculation
There are three main variables that one needs to collect in their customer data in order to calculate customer lifetime value. Once we have the data for the variables, one can simply multiply them and get their customer lifetime value. Let’s look at the three variables:
1. Average order value
This data is simple as the name suggests the value of your average sales. A month’s or six months of data can act up as a proxy for a year’s data in case you were not tracking this data.
2. Average number of transactions per period
This variable is all about the frequency with which a customer interacts with the business’s products or services. For some businesses, customers might be very frequent for instance, coffee shops and for some businesses, the frequency of interacting with the business might be less, for example, car or motorbike dealerships.
This variable is concerned with the average length of time for which a customer remains loyal to the business. For some businesses, this can be a longer time frame in which businesses enjoy long-term customer loyalty while for some businesses there is very low customer loyalty.
Now that we know of all the three variables that are required in order to calculate customer lifetime value, we now simply need to multiply them in order to get our CLV, so that becomes-
CLV = Average order value x Number of transactions x Customer retention period
Each variable in calculating CLV is affected either directly or indirectly by any decision taken by the business. For instance, if you increase the price of the product or service offered by your business, it will increase the value of your average order value but at the same time might have a negative impact on both the number of transactions and customer retention period as people will go out, looking for an alternative to your product.
For this reason, the marketing officers become crucial as they are familiar with the 4 Ps of marketing, namely Price, Product, Place, and promotion, and their likely impact on the variables of customer lifetime value.
Numerical examples of calculating CLV
Let’s look at two different examples and understand how two different types of businesses can have a completely different CLV and what they imply for that business.
A coffee shop is a type of business that has a low order value, a higher frequency of transactions, and can have a higher retention period depending on the type of product and service provided by the coffee business outlet.
For our understanding, let’s assume that the order value is $5 with an average annual visit of 100 times a year with a customer retention period of 4 years. With this information, we can now calculate customer lifetime value (CLV) for coffee shops.
CLV = 5(average order value) x 100(number of transactions) x 4(customer retention period) = $2000
So, for a coffee shop, a customer gives $2000 revenue or value to the business.
A car dealership business is one with high order value, a lower frequency of transactions, and a higher retention period.
With this, let’s give variables some numbers and have a clear understanding of CLV calculation. Assuming that the average order value is $20,000 with an average annual visit of 1 time a year for a retention period of 5 years. With this information, we can now calculate customer lifetime value (CLV) for car dealerships.
CLV = 20,000(average order value) x 1(number of transactions) x 5(customer retention period) = $1,00,000
So, for a car dealership, a customer gives $1,00,000 revenue or value to the business.
With the above examples, we can clearly understand that customer lifetime value will be different for different types of businesses in different industries.
Improving customer lifetime value
There are numerous ways and strategies in which one can improve their customer lifetime value. Different strategies work for different businesses but there are a few strategies that are common across all businesses in any industry.
Increased focus on improving customer experience
Customer experience is not formed based on any one factor. Rather, it’s an accumulative result formed by a customer by incorporating their experience in all touch points of the business. Be it looking at an advertisement, visiting the store or after-purchase follow-up, or customer support, businesses need to focus on ways and strategies which will help in improving the customer experience across all touch points.
Seamless customer onboarding
When a person interacts with your business that will be the first time he will be forming an opinion about your business which will decide whether the person will remain loyal to the business or will find an alternative for the product or service. Therefore, it becomes very important to have a seamless onboarding experience where a person turns into a customer for business and will choose to remain loyal to them.
Customer loyalty reward programs
Rewarding your customers that are loyal to your business is a great way to incentivize them to keep coming to your business. One can have punch cards, purchase points, and many other things that can act as an incentive for the customers.
Closed loop feedback
Closed loop feedback is majorly for customers that are churning away from your business. This means paying extra attention to the customer drifting away or likely to drift away from your business and turning them into loyal customers.
What is the customer lifetime value formula?
Customer lifetime value (CLV) formula is Average order value x Number of transactions x Customer retention period.
What is customer value?
Customer value is the total amount of revenue that a customer has generated for the business from the first time he has interacted with the business.