Everything You Need to Know About Customer Lifetime Value: CLV 101
In this short series, we focus on Customer Lifetime Value (CLV) as a part of the bigger picture surrounding customers. Learn more about its role, what is it good for and what does it show.
Understanding CLV and How to Calculate It
Customer Lifetime Value (CLV) is a metric mostly used in marketing and sales. Simply put, CLV is the average monetary value that a company should expect to generate from a single customer over the lifetime of their business, that is the period through which the customer conducts business with the company.
There are various approaches to calculating CLV, both in terms of formulation and focus. While simpler CLV formulas take into account the average order value, average number of customers, and average customer lifetime; more complicated formulas integrate other elements, such as cost of services, cost of customer acquisition, and discounts, into the calculation. For consistency, we will refer to the following formula, also known as the traditional formula, for calculating CLV:
Where CLV stands for Customer Lifetime Value, GML stands for Gross Margin per Customer Lifespan, which is obtained by multiplying the Average Profit Margin and Average Total Revenue per Customer over their entire lifespan. R stands for retention rate, that is, the percentage of customers that the company was able to retain during the specified period. Finally, D stands for discount rate, which is a set percentage but may vary in different contexts.
Admittedly, even this equation is rather complex, and there will rarely be any situation where you or someone in your team will need to perform this calculation on the spot. Nevertheless, it will help to show why a holistic approach to CLV is necessary.
What Does CLV Show?
CLV is a versatile metric that can be used both retrospectively and for prediction purposes. In both historical and predictive CLV calculations, data and analytics are crucial to improving the accuracy and reliability of analyses. For instance, data and analytics can be used to determine customer segments, how each segment interacts with your company, the value generated by different segments, as well as the average duration through which the customers are expected to conduct business with your company. Further, comparing the cost of acquiring new customers (CAC) or rolling out a new marketing campaign for a product line to the revenue generated as a result of each activity provide important insight into the profitability, health and sustainability of the business.
Historical CLV calculations can be used to better understand past performance by using data on past purchases and transactions. The historical approach can help companies to better understand the changes in their relationship with customers, as well as the effectiveness of their marketing campaigns and other operations. On the other hand, CLV can be used to inform strategic decisions about an enterprise’s products and services, operations, sales, and marketing activities. Technology, artificial intelligence (AI) and machine learning can be leveraged for such a predictive approach. Insight generated from past performance can inform extrapolation on future scenarios concerning revenue expectations, sales performance, or the customers’ likely reception of a future line of service or product.
Overall, CLV helps to answer questions such as:
- How well does our company retain customers?
- How effective are our marketing and outreach efforts?
- Are there inefficiencies in our sales and operational activities?
- Which products or services appeal most to our customers?
- Based on what we know from past trends, how much profit should we expect to generate over the next cycle?
What is CLV Good For?
Answers to the above questions not only provide a snapshot of a company’s current state in terms of customer acquisition and retention, but they also point to areas of improvement for growth. Boosting CLV helps to:
- Generate better return on investment (ROI) from marketing and sales activities
- Increase customer loyalty and satisfaction
- Strategically target different customer segments based on their preferences
- Acquire new customers while contributing to the sustainable growth of the business
CLV is not just a metric that indicates the profitability of your business or effectiveness of your marketing activities. It points to a higher-level transaction regarding how well your products and services were able to satisfy the needs and expectations of your customers. The greater the match, the higher customer satisfaction will be. Highly satisfied customers will also be more loyal and stay with you longer. They will also be more likely to contribute to your growth through repeated purchases and referrals. The potential of CLV as a metric that informs your decisions regarding marketing and sales, and as one that provides an opportunity to get to know your customers better can be further unleashed with a more holistic approach. In Part II of this series, we present how we can re-imagine CLV and customer relationship, along with how, here at Digitopia, we can assist you with your transformation journey.
