What Is Customer Lifetime Value and How Do You Calculate It?

Itai Elizur
Fri, 11 Oct 2024 12:04:00 +0000
Clv, Customer-value, Ecommerce, Email-marketing, Engagement, Lifetime-value, Marketing, Sales, Scaling, Growth, Scaling-business, Customer-lifetime-value

Businesses looking to find their footing are often obsessed with metrics. However, not all metrics are created equal for those hoping to survive over the long haul.

The difference between businesses that fail and those that scale? Understanding what their customers are worth by the numbers. It doesn’t matter what kind of business you want to start. From the world of e-commerce to brick-and-mortar stores, scaling is near-impossible until you determine your customer lifetime value.

What is customer lifetime value (CLV)?

Customer lifetime value (CLV) represents a relatively simple concept that can make or break a budding business. In short, your CLV is the total dollars that a customer will spend with your company over the course of their lifetime.

There are numerous ways to calculate your CLV, but this straightforward formula perhaps illustrates it best:

(Average Value of Sale) X (Number of Repeat Transactions Per Year) X (Average Retention Time) = CLV

Don’t let the math freak you out. Again, the concept is simple.

Let’s say you run an e-commerce store that sells seasonal clothing. The average value of any given sale at your shop is $30, your customers on average purchase from you twice a year, and they typically stick around for two years. In this scenario, your CLV would be $180 (30 x 2 x 3).

But why does this number matter so much?

Why you need to know your CLV

The key benefits of understanding your CLV are threefold:

Knowing how much your customers are worth shows you what you need to bring new people into your funnel, especially since acquiring new customers costs more than retaining them.

Your CLV directly influences your marketing strategy. From purchasing media and hiring sales personnel to looking for affiliates and beyond, knowing what your customers are worth will ultimately determine your marketing budget.

You will avoid scaling too quickly and have a better understanding of what your business requires to break even.

The takeaway here is that having your CLV handy means that your business’s budget and earning potential are rooted in numbers rather than a guessing game. Yet despite there being a need to understand your CLV, many new businesses struggle with the concept.

RELATED: Customer Retention: 6 Techniques to Cultivate and Build a Stronger Customer Base

Setting up a system that predicts your customers’ value

The problem for a budding businesses and its CLV is perhaps obvious. That is, determining how much your customers are worth is easier said than done if you don’t have a particularly large sample of customers or haven’t been around long enough to have numbers to crunch. Similarly, you may have no indication of churn rate or what your business’s cash flow looks like for the long term.

Does that mean that new businesses are expected to fly blindly? Of course not. The solution is to create a system that essentially predicts your CLV.

Perhaps one of the best illustrations of such a system comes from the world of app developers, a high ad-spend vertical with fierce competition. Developers essentially set up a series of actions for users to take within a certain time frame to estimate how much those users will be worth in the long run. Those actions might include:

Completing a tutorial

Making a purchase with their app

Leaving a rating on the app in the App or Play Store

Each of these actions serves as a sort of indicator as to how engaged their audience is. The more engaged they are, the higher their potential CLV.

Businesses beyond the world of apps can apply the same rules to new marketing channels. Take email marketing, for example. Relevant email indicators for CLV might include clicking through a particular message or redeeming an email-specific coupon code.

But what about new businesses?

For new or lead-centered businesses, it’s crucial to define the rate in which you’re able to close leads. Once you’ve determined that, creating a cost per-lead metric (CPL) allows you to figure out which marketing channels are worth scaling and which ones are not.

The sales and marketing methods that bring in business at the lowest cost per lead are the ones worth scaling, as long as you’re seeing a positive ROI. On the flip side, be wary of tactics that result in a sky-high CPL and don’t close leads at a positive rate.

Once you’ve ironed out these metrics and figure out what it costs to bring someone new into your funnel, you can begin to better understand your CLV down the line.

How your customer lifetime value helps you scale

If you want your business to realistically scale, understanding the ins and outs of your CLV is everything. After all, your long-term goal is to increase the value of your customers over time, meanwhile keeping the cost acquiring new leads as low as possible. Once you’ve determined what your customers are worth, there are no question marks surrounding what you need to do to bring in more business.

Think about the three elements which make up your CLV. By raising the average value of your sales, encouraging repeat transactions, and offering incentives for your customers to stick around, your bottom line has nowhere to go but up. Meanwhile, that newfound cash flow can be used to find new opportunities to acquire new leads.

Your CLV supports the longevity of your business

Your CLV is at the core of your business’s growth. Using data to understand what your customers are worth allows you to make more informed decisions in regard to marketing and growth. From scaling to simply keeping the lights on, your CLV is arguably the most important metric for your business’s survival.