A Complete Guide to Customer Lifetime Value

All customers are good for a business, but the right customers are invaluable.

What does that mean?🤔

Over time, your business would come across many kinds of customers. Some would shop with you once and disappear, some would return for seconds, while a select few would decide to stick with you for the long term.

You should pay extra attention to these "long-term" customers; Bain corroborates that in this report. Their research has established that a mere 5% increase in customer retention can help your business boost profits by as much as 95%.

Your business needs calculable, actionable metrics to differentiate one customer from the next, based on the “quality and quantity” of the business they would do with you. Naturally, you wouldn’t want to spend resources wooing a customer who isn’t likely to stick around; how, then, do you find this needle in the haystack?

The answer lies in understanding what customer lifetime value (CLV) is. Truth be told, you can call it an offshoot or a subset of customer loyalty— the higher it is, the better for your business.

Consider these numbers: Chick-Fil-A, one of the largest fast-food chains in America, has so expertly capitalized on customer loyalty marketing that they are in a position to pay their employees almost triple the industry standards. They also have the bandwidth to donate a part of their profits to charity.

The power of knowing the customer lifetime value and the loyalty of each customer your business owns is the key to unlocking steady, sure growth.

What is Customer Lifetime Value?

Customer lifetime value is the total worth of a customer to your business over the time they remain associated with you.

You can read that again: knowing each customer's lifetime value helps your business optimize its resources for customer experience strategies.

It is a fact that equitable treatment for every customer isn’t advisable for long-term growth goals. Harvard Business Review, in their research, discovered that it costs a business anywhere between 5 and 25 times more to acquire a new customer than to retain an old one.

Collating this data with the earlier statistic that loyal customers deliver more profit, the importance of measuring the worth of each customer to a business becomes clear as day. Calculating the customer lifetime value, thus, helps your business chart a growth strategy that adjusts the resource allocation based on customer worth.

Let’s take an example to understand it better. Assume that Customer A searches for an item but abandons the cart after engaging with your sales team for two months. On the other hand, Customer B is a returning customer who has shopped with you twice in two months.

Seeing how Customer B could be made loyal, your business should attribute more resources to retain him and adjust strategies to groom Customer A for sales. The strategy,  resource allocation, and team engagement would be different.

The only thing that changes here is the customer lifetime value. By working to retain Customer B, your business is increasing its worth, just as Bain reported. Going back to the Harvard finding, Customer A is the kind that would cost your business up to 25 times more to acquire.

Weighing them on the scale, Customer B is worth more to your business than Customer A— knowing this is what customer lifetime value is all about.

How to Calculate Customer Lifetime Value?

Much like any other business metric, customer lifetime value can be calculated. In fact, there are several steps involved to arrive at the lifetime value of a customer:

1. Calculate Average Purchase Value
2. Calculate Average Purchase Frequency Rate
3. Calculate Customer Value
4. Calculate Average Customer Lifespan
5. Arrive at Customer Lifetime Value

Calculating Average Purchase Value

To know the Average Purchase Value, you need:

• Total revenue for a specific period. Let’s assume this to be $10,000 over 500 days
• Number of orders during that period. Let’s say there were 1,000 orders over 500 days

APV = (Total Revenue) / (No. of Orders)

APV = $10,000 / 1,000

APV = $10 per order

Calculating Average Purchase Frequency Rate

To calculate APFR, you need:

• Number of orders (which was 1,000 for the decided period as earlier)
• Number of customers. Let’s assume your business has 500 customers

Average Purchase Frequency Rate = (Number of Orders) / (Number of Customers)

APFR = 1,000 / 500

APFR = 2 orders per customer

Calculating Customer Value

To calculate customer value, you need:

• Average purchase value
• Average purchase frequency rate

Both these parameters have been calculated earlier.

Customer Value = (APV) x (APFR)

CV = $10 x 2

CV = $20 per order

On average, each customer gave you $20 worth of business over the decided period of time.

Calculating Average Customer Lifespan

To calculate this parameter, you need:

• Number of customers (500, as per continuing example)
• Sum of customer lifespans. Let’s assume this number to be a total of 100,000 days

Average Customer Lifespan = (Sum of Customer Lifespans) / (Number of Customers)

ACL = 100,000 / 500

ACL = 200 days per customer

Calculating Customer Lifetime Value

To calculate CLTV, you need:

• Customer value. $20 per order, as calculated earlier
• Average customer lifespan. 200 days per customer, as calculated earlier;

CLTV = CV x ACL

CLTV = 20 x 200

Average CLTV = $4,000 over a period of 500 days

Customer Lifetime Value Models

Arriving at the consumer lifetime value data alone is merely a quantitative beginning towards understanding the worth of your customers. A more in-depth, qualitative, and consistent insight into this metric is required for it to become strategically actionable. For this purpose, various modeling methodologies exist that help put the lifetime value marketing data into better perspective and deliver a holistic picture of each customer over longer terms.

Three CLTV models are widely used today; let’s see what they are.

#1: Descriptive Model

The descriptive model is a quick way to understand consumer purchase behavior by gleaning from their previous purchasing habits. This behavioral analysis is done mostly manually, providing an immediate hypothesis on where a consumer will likely go with his shopping intention. While this is a quick method for immediate use, it has little accuracy and value; a more robust analysis is needed to yield definitive results. Hypothesizing consumer behavior can only take a business so far.

#2: Predictive Model

The predictive model is an improvement over the descriptive model. Based on the historical patterns of a consumer, the model derives insight and extrapolates it over the average consumer lifespan to predict the future customer lifetime values. This model is more accurate and reliable and yields results that can be acted upon by creating meaningful, informed strategies.

However, even this model needs complicated analytical capabilities and huge amounts of consumer data to make the results truly insightful.

#3: Operative Model

The operative model is the modern method of determining highly accurate and actionable customer lifetime values. Dedicated software that employs the power of Artificial Intelligence and Machine Learning automatically predicts, extrapolates, and collates consumer data to create a holistic picture of customer lifetime values. They also provide initial recommendations for action to the decision-makers, expediting the launch of strategies that are likely to work favorably.

Furthermore, the cognitive system improves its function with each iteration, delivering more accurate values with each turn. This shifts the focus of the operational teams from deciding on recommendations to feeding quality data to the system.

Ways to Increase Customer Lifetime Value

Customer lifetime value consists in designing an end-to-end experience for a customer and delivering quality and value at each touchpoint. By following the guide below, this can be achieved.

#1. Improve customer experience: Make each touchpoint count, whether it be an in-store contact or gaining a customer through landing pages. Deliver a high-quality customer experience that is proactive and relevant to the customer.

#2. Minimize customer effort: No customer has the time to follow elaborate rules or steps to get on board with your brand. Make the onboarding process extremely pointed, seamless, and precise, and time it right.

#3. Consider a loyalty benefit or program: Customers love offers and benefits – start by prioritizing your repeat customers. Offer them special perks through loyalty programs that they can join by choice. Here's an example:

#4. Acknowledge the customers who love your brand: Rewards and recognitions for customers who promote your brand are a great way to keep them happy and also empower them to bring in more customers.

#5. Increase customer touchpoints: Leverage the power that an omnichannel system brings with it. Not only would you increase your outreach with omnichannel, but you would also give your customers convenient ways to get in touch with your brand.

#6. Be active on social media: Social media is big today – let your customers catch a glimpse of your activities through a social media brand page. Better yet, make them a part of it through hashtags and other trends.

#7. Pay attention to unhappy customers: They can influence new leads to steer away from your business by leaving negative reviews on public platforms. It is always better to be proactive and understand their pain points to arrive at a compromise or solution before matters escalate and harm your business.

Wrapping up

Customer lifetime value is a multifaceted aspect that businesses can leverage to:

• Improve customer worth
• Improve customer retention
• Drive growth by boosting profits
• Build a solid reputation for the brand by actively polishing customer experiences and achieving customer advocacy

Utilize the guide above to strategize for your own customer lifetime value booster campaign.

References

McKinsey