Customer Lifetime Value
Determining how much to spend on your marketing efforts can be tricky business. On the one hand, you are going to need to invest in advertising initiatives if you are going to acquire customers and move your business forward. On the other hand, if you are spending more money on advertising than you are making from the customers you acquire, you will be playing a losing game in the end. The only way to know how much you can afford to spend on marketing is to know how much money you are going to make from the customers you gain.
This is where customer lifetime value comes into the picture. The idea here is simple – to determine how much each new customers is going to be worth to your business over the entire lifespan of their relationship with your business. Of course, this number is always going to be a prediction rather than hard facts, as you can’t know for certain how much money the average customer is going to spend in years to come. However, through the use of established models and methods, you can make accurate and meaningful decisions which will drive your decision making process.
Looking Back to See the Future
One of the best ways to see into the future on just about any topic is to look into the past. That is certainly true when it comes to customer lifetime value, as you can base your projections on actual events that have occurred in your business previously. By using statistics from previous transactions and customer behaviors, you will be able to calculate what you can expect new customers to be worth to your company.
So what information would you need to work up an accurate customer lifetime value projection? The following pieces of data will be helpful in this pursuit.
- Average order value for your business. When customers make a purchase from your company, how much do they typically spend? This is a piece of data that should be relatively easy for you to calculate, if you don’t already have it on hand. To do the math, simply divide the total revenue that you have brought in over a given period of time by the number of orders you accepted in the same time. So, if you decide to use last month’s numbers, you can divide your revenue for the month by the total orders placed. The resulting figure is your average order value.
- Frequency of customer purchases. The next thing you will want to know is how often the average customer is going to buy something from your business. Do most of your customers come back each week, or do they only buy a couple things per year? Again, some simple math can give you this number. Take the number of orders you have collected over that same month, and divide by how many unique customers you served in that month. If you accepted 100 orders and there were 50 customers, you would obviously have a frequency of two orders per month per customer.
- Lifespan of a customer relationship. Finally, you are going to need to determine how long the typical customer stays with you. This one is a little harder to figure, as there will be some assumptions made on when a customer is no longer considered active. Take a look at your customer database and pick a cutoff point at which you no longer think a customer should be seen as active. This could be as little as a few months for a business with high customer frequency, or as long as a few years for a business that sells big ticket items.
With the pieces of information listed above all collected, you can go on to figure out how much value to assign to each new customer you acquire.
Finding Your CLV
To bring everything together, you can now use the math that you have done above to put together a customer lifetime value for your business. Again here, the math is quite easy. First, you are going to multiply the average order value by the customer purchase frequency. For instance, if you had an average order value of $10, and your typical customer made two purchases per month, each customer would be worth $20 per month to your business.
For the final step, you are going to multiply that figure by the average lifespan of your customer that you determined above. If you have decided that your typical customer remains engaged with your business for 30 months, you would multiply 30 by $20 to come up with a final total of $600. In this very basic example, your customer lifetime value would be $600 in revenue. That is not profit, of course, so you could then go on to incorporate profit margin numbers to determine how much profit is generated by each new customer.
Using this Information
This information is only going to be helpful if you actually use it to make decisions. To start with, you will want to think about customer value in reference to marketing investments. If you are spending more to attract a customer than you are going to make in profit over the lifespan of their purchases with your business, you obviously need to make changes.
Calculating an overall customer lifetime value is beneficial all on its own, but it can become even more beneficial when you segment your numbers out into groups. You could, for example, segment your customer data by the acquisition method used to bring in those customers originally. Then, you would be able to see which advertising channels were bringing back the customers with the highest lifetime value. By investing additionally in the most profitable channels, and scaling back on those with a lesser return, you can gradually improve the efficiency of your marketing investment.
Customer lifetime value is a metric that is rather easy to calculate and yet can provide you with a tremendous amount of insight into your business. Take the time to determine what kind of value you are getting from various customer segments and you should be on track toward improved profits and a brighter future.
You can read more about Customer Lifetime Value in our free eBook ‘Top 5 Marketing Principles’. Download it now for your PC, Mac, laptop, tablet, Kindle, eBook reader or Smartphone.
- The only way to know how much you can afford to spend on marketing is to know how much money you are going to make from the customers you gain.
- Customer lifetime value is how much each new customer is going to be worth over the entire lifespan of their relationship with your business.
- The information required to calculate accurate customer lifetime value is the averages of: order value, frequency of purchase and the lifespan of the relationship.
- You could then go on to incorporate profit margin numbers to determine how much profit is generated by each new customer.
- Used in conjunction with customer segmentation, customer lifetime value enables you to see which marketing channels are the most profitable.