You can have the best business idea in the world.
Your products can be incredible, unique, and revolutionary in your industry.
Your branding can be so clean and sleek that it makes the brand strategists at Apple blush.
But brand loyalty and sleekness is all worthless if you don’t have customers.
Loyal customers have the largest Customer Lifetime Value (CLTV or CLV).
But what CLTV? How is customer lifetime value calculated?
And most importantly, how do we increase and maintain Customer Lifetime Value?
What is Customer Lifetime Value?
In the most basic sense, customer lifetime value (CLV) is a metric used to indicate the total revenue a business is likely to expect from an average customer. It looks at the customer’s revenue value and then filters it through the company’s predicted customer lifespan. Companies can use this metric to quickly analyze the profitability of certain customer segments, which enhances their ability to target the right demographics.
CLTV essentially tells businesses how much each customer is worth, not just in the short-run (i.e. the first purchase), but over their entire business relationship. Naturally, the longer a customer sticks around and the more customer loyalty they have, the greater their customer lifetime value is. In short, spend time on value-adding customer relationships when you know each customer is worth a great deal to you.
In addition to providing clarity for the business, CLTV also acts as a motivator for serving customers well and encouraging loyalty through exceptional quality and service.
Why Does Customer Lifetime Value Matter?
In just a moment, I’ll walk you through how to calculate customer lifetime value (CLTV). (I’ll even give you a real-world example to help bring the equation to life.) But first, I want to dig a bit deeper and explain precisely why customer lifetime value matters on a granular level. Here are a few of the top benefits:
1. CLTV Tells You How Much to Spend
Most businesses are pretty bad at doing the math required to understand how they’re really doing financially. It’s not that they’re incapable of doing the math, they just don’t know where to look or which metrics to use.
We commonly see businesses spout off the cost to acquire a customer. This is a great start (and a very important metric). But in all honesty, customer acquisition cost (CAC) is useless information if you don’t know your customer lifetime value.
CLTV brings your CAC to life. Suddenly, you’re not just staring at a number that tells you how much it costs to bring on a customer. Now you have the context of how much value that customer brings you in return. And when you compare the two, you know precisely how much to spend in order to grow.
Every business has a different equation/threshold. Many software companies, for example, want their LTV to be at least 3X their CAC. In other words, if it costs them $100 to acquire a customer, they want a minimum LTV of $300. Other businesses might be fine with 1.25X CAC. They’re fine spending $10 to acquire a customer as long as it brings them $12.50. (Because they know that there’s big money to be made at scale.)
Hopefully, I’m not getting too deep into the technical weeds here, but I just want to show you one reason why customer lifetime value is so important. Once you understand this metric, it gives you the ability to make sound decisions about how much you spend. In many cases, it frees you to open up the “wallet” and spend more without feeling guilty.
2. Customer Lifetime Value Helps You Understand Customer Behavior
Another benefit of understanding your CLTV is that it helps you get clear on customer behavior. You’ll quickly learn that not every customer is worth the same (even if they make the same exact initial purchase).
For example, when you calculate customer lifetime value (CLTV) against each origination source (referral, organic search, cold sales outreach, etc.) tells you where your time is best spent. You may find that a customer who makes a purchase after seeing a Google ad and visiting a landing page is worth $1,000 over their lifetime. But then you discover that a customer who is referred to your business and speaks to a member of your sales team before buying is worth $5,000 over their lifetime. That’s valuable information that will shift the way you operate.
Another benefit of knowing CLTV is that you can use lookalike modeling to acquire more customers that meet specific demographics. Facebook makes this really easy. If you know that 25-30-year-old female college graduates working in IT give you the highest CLTV, you can model this demographic and ask Facebook to go after similar high-value customers.
3. CLTV Shifts Your Focus From Customer Acquisition to Customer Retention
Most marketing and sales professionals are geared to focus on acquisition. (Naturally, that’s what their job entails.) Unfortunately, we live in a business culture where acquisition gets too much of the focus. It’s exciting and energizing to add a new customer, so we get caught up in the notion of more, more, more! But CLV does a good job of gently reorienting how you think, to focus more on existing customer retention rather than customer acquisition.
Research shows that reducing your churn rate by just 5 percent can increase your company’s profitability by 25 to 125 percent. That means a simple CLTV-based strategy can fundamentally change your bottom line.
If you look at the popular Pareto Principle, you’ll find that 80 percent of your revenue comes from 20 percent of your existing customers. Again, customer lifetime value tells you where to focus.
The Customer Lifetime Value Equation
Calculating customer lifetime value requires a few pertinent pieces of information. This starts with calculating “customer value,” also known as CV.
To calculate CV, you need two data points:
- Average purchase value (APV). The average purchase value is calculated by taking total revenue and dividing it by the number of transactions. Thus if your total revenue over the period is $10,000 and you have 1,000 orders, this means your APV is $10.
- Average purchase frequency (APF). This metric tells you how many times an average customer makes a purchase from your business over that period. You can calculate this number by taking the total number of purchases and dividing it by the number of customers. If the total number of purchases is 1,000 and the number of customers is 500, this means your APF is 2.
The customer lifetime value formula looks like this: CV = APV x APF
The next step is to calculate customer lifetime value, which requires you to know the following:
- Average customer lifespan (ACL). The next step is to identify the average customer lifespan. You get this number by taking the sum of customer lifespans and dividing it by the number of customers.
Armed with this average customer lifespan data, you can run the full equation: CLTV = CV x ACL
If you’d rather think about it as one big equation (instead of two parts), here’s the full breakdown: CLTV = (APV x APF) x ACL.
While you may find this equation a bit overwhelming, rest assured you don’t have to calculate all of these metrics manually. Once you have the correct data sources in place, there are software applications that will quickly automate your CLTV numbers in real-time.
A Real-World Customer Lifetime Value (CLV) Calculation
Let’s flesh the customer lifetime value (CLV) equation out a little more by looking at a real-world calculation. We’ll use data from a Kissmetrics report on Starbucks. It’ll measure the CLTV of five customers based on weekly purchasing habits. Here are the steps:
Step 1: Calculate the average purchase value. According to the data, the five customers spend $3.50, $8.50, $5.00, $6.50, and $6.00, respectively. That brings the average customer purchase value to $5.90 per visit.
Step 2: Calculate the average purchase frequency rate. The five customers visit four times, three times, five times, six times, and three times, respectively. This gives us an average customer visit of 4.2 per week.
Step 3: Calculate the average customer’s value. To perform this calculation, we multiply each customer’s expenditures by their number of visits and then average the numbers out. This gives us a CV of $24.30.
Step 4: Calculate the average customer’s lifespan. Based on the data provided, we know that the average customer’s lifespan is 20 years. You might not have that much data to work with, so another workaround is to take the number one and divide it by your churn percentage.
Step 5: Calculate your CLTV. Now we’re ready to conduct the total customer lifetime value. To do this, you take your ACV figure ($24.30) and multiply it by 52. This gives you an annual customer value of $1,263.60. Then you multiply that by 20 (customer lifespan) and it gives you $25,272.
While these numbers aren’t necessarily the same ones Starbucks uses, it probably isn’t that far off. So now you can see why Starbucks is willing to spend so much money in marketing and advertising. I’m not sure what their ideal multiple is, but I can promise you they don’t care if it takes $50, $100, or even $1,000 to acquire a customer who is going to generate $25,272 over their lifetime.
Your numbers might be smaller or larger than this. But either way, once you understand customer lifetime value, it changes the way you approach your business. You’ll either realize you aren’t doing enough to acquire the right customers, or you’re overspending on customer acquisition costs to acquire the wrong customers.
How to Increase Customer Lifetime Value (CLV)
Calculating customer lifetime value is the first step. But once you have an idea of what your numbers are, you can begin looking at ways to improve your metrics. Here are some specific ideas:
1. Front load the Value
First impressions are everything for a customer. You can blow someone away with a good deal, but if there isn’t a memorable interaction or meaningful degree of value attached to their purchase or product experience, they’re unlikely to return over and over again. This limits their lifetime value and leads to high churn rates.
By frontloading the value, you’re able to create exceptional experiences that the customer takes with them and remembers – ultimately compelling them to return over and over again.
Front loading value looks like going above and beyond. It’s all about improving customer satisfaction for high value customers, ensuring better customer retention rates long term.
Let’s say, for example, that you’re selling a software application. In addition to giving them access to the software, you may offer 12 months of free support and coaching (which is something you normally sell as an add-on). You can also include a free book or course that you’ve created. Then on top of that, you discount the initial price for several months. All of these little elements work together to give the customer a sense of added value.
The problem is that most businesses are unwilling to front load value because it may mean losing money on the first sale. But if you understand CLV, you’re fine losing a small amount of money on that initial transaction. Yes, it’s possible that some customers will never return. But when you average things out, you know you’ll be in the black.
2. Motivate Your Team
One idea is to use customer lifetime value (CLV) as a motivator for your sales reps and customer service professionals. With the right CRM system in place, it’s pretty easy for B2B businesses and even some B2C companies to track where customers come from and which team members are responsible for bringing them into the brand’s ecosystem. It’s also easy to see which team members are responsible for nurturing them over time. Use this to your advantage.
By creating a system where you judge a team member’s performance based on their ability to promote greater CLV among the customers they come into contact with, you create a culture where lifetime value (not short-term sales) becomes the focus. This gives everyone a greater sense of clarity and perspective.
If you’re confident that you have the ability to accurately measure and track customer lifetime value by employee, attaching a bonus or incentive plan to this number can take your efforts to an entirely new level.
3. Up-Sell and Cross-Sell
One of the best ways to increase a customer’s value is to get them to purchase more. Let’s say, for example, that you have 5,000 customers and they spend an average of $10 per month. That means your top line revenue from those customers is $50,000 per month. But what if you could increase that average purchase size to $12? On the surface, that sounds pretty worthless. But when you run the numbers, you’ll find that a simple $2 increase leads to another $10,000 in monthly revenue ($120,000 over the course of a year).
The question is, how do you get that $2 increase? The easiest way is to introduce up-sell and cross-sell strategies into your sales process.
As you probably know, an up-sell occurs when you get a customer to upgrade/add on services and/or purchase a more expensive version. For example, if a customer was planning to buy a $100 pair of headphones, up-selling looks like getting them to upgrade to a nicer version that’s $129. Or it could look like selling them a warranty that’s $9 for the year. Either way, you got them to spend more for essentially the same thing.
A cross-sell occurs when you increase that customer’s transaction size by getting them to supplement a purchase with a complementary product. Using the example of headphones, you might get them to purchase a case to go with the headphones. Or an extreme example would be talking them into buying a new phone that will improve their ability to stream music.
4. Create Sticky Features
The best way to get a customer to stick around is to add sticky features to your products that make it difficult and painful for them to leave. (Ethically of course.)
Software companies are really good at creating truly loyal customers. They often develop features where businesses become dependent on their data sources or dashboards. And if they leave, they lose those insights.
Facebook is another good example. There are millions of users who would probably leave Facebook, but they won’t because the platform stores all of their photos. While they don’t say so explicitly, I’d imagine the reason they don’t allow users to download all of their Facebook photos in one simple file is that they see pictures as a sticky feature. They know people won’t delete their accounts because they store so many family memories.
What sticky features can you create? Whether you sell a digital subscription service or a physical product, there are opportunities to keep customers coming back for more.
5. Build Your Brand and Communicate Often
You can’t go radio silent after a customer makes a purchase. This isn’t the end of the road – it’s just the beginning. It’s at this point that you need a specific and intentional strategy for dripping on your customer.
You’ll have to decide what this looks like, but many brands use content as a way of keeping the embers burning. For example, they send out a 60-day email sequence that sends targeted messages on Day 1, Day 3, Day 7, Day 15, Day 30, Day 45, and Day 60. These emails may do any number of things, including offering support, showing social proof, or directing readers to blog content that’s educational and informative.
Ultimately, this copy – whether in email or blog form – is designed to nurture the customer and encourage future purchases. The result, of course, is an increase in customer lifetime value.
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