## Acronym definition and calculation

What is Customer Lifetime Value (CLTV, or CLV)?

Why is Customer Lifetime Value Important?

How to Calculate Customer Lifetime Value (CLTV, or CLV)

How Much Are Your Customers Costing You?

Tips to Increase CLV

FAQ

### What is Customer Lifetime Value (CLTV, or CLV)?

Customer lifetime value (CLTV, or CLV) is a measure of the total income a business can expect to bring in from a typical customer for as long as that person or account remains a client. It’s an important metric because it’s a measurement of how valuable a customer is to your company, not just on a purchase-by-purchase basis but across the entire lifetime of the relationship.

### Why is Customer Lifetime Value Important?

Knowing that it costs less to keep existing customers than it does to acquire new ones, increasing the value of your existing customers is a great way to drive revenue growth and profits.

By knowing your CLV on an account or customer by customer basis allows you to determine which customers or accounts contribute the most revenue to your business. This allows you to serve these existing with products/services they like and make them happier, resulting in them spending more money at your company.

CLV can also be used to target your ideal customers. When you know the lifetime value of a customer, you also know how much money they spend with your business over a period of time. With that knowledge, you can develop a customer acquisition strategy that targets similar customers.

### How to Calculate Customer Lifetime Value (CLTV, or CLV)

To get started calculating customer lifetime value, you need to calculate the average purchase value and then multiply that number by the average number of purchases to determine customer value. Then, once you calculate the average customer lifespan, you can multiply that by customer value to determine the total customer lifetime value.

Simply put, the formula for Customer Lifetime Value = (Customer Value * Average Customer Lifespan) where Customer Value = Average Purchase Value * Average Number of Purchases.

### Customer Lifetime Value Example Calculation

For example, a fictitious coffee shop chain called EZ Bean has three locations and has an average sale of \$5 per customer. The typical customer is a local worker who visits two times per week, 50 weeks per year, over an average of 5 years.

With the above information we now have all the variables needed to calculate the CLV for EZ Bean.

CLV = \$5 (average sale) x 100 (annual visits) x 5 years (lifespan) = \$2,500

### How Much Are Your Customers Costing You?

A metric that usually comes along with CLV is Customer Acquisition Cost (CAC). CAC considers the costs of acquiring a new customer, such as sales and marketing expenditures. The purpose is to compare the lifetime value of a customer and the expense of getting a new customer for decision-making related to business viability.

The formula for CAC is sales and marketing costs divided by the total number of new customers during the same period. Sales and marketing costs include salaries, advertisements, campaigns, and promotions. The number of new customers is the total headcount of new customers you have at a specific length of time.

Customer Acquisition Cost = Sales and Marketing Costs / New Customers

For example, if a retailer has a CLV of \$100 while CAC is \$150, it means that the business is not profitable due to the high CAC. In this case, the retailer should review its costs for sales and marketing because it doesn’t generate any profits from getting new customers. Based on the above example, we can see how breaking down CLV and CAC offers insights into financial conditions and future profitability.

Examining the relationship between CLV and CAC reveals the significance of a customer to your business. If a customer's CLV is unusually higher than others, are the costs of getting that specific customer the same? In contrast, if a customer costs you a lot more to acquire than the others, does it affect that customer's CLV? Understanding CLV and CAC metrics allows you to investigate these questions.

Businesses also examine Cost to Serve (CTS), which associates with all the cost factors to deliver the products or services to a customer. The calculation of CTS may involve allocating fixed costs to servicing a customer, such as transportation, warehouse, product returns, and call center expenses. Looking into CTS helps you reduce servicing costs and improve internal processes.

CTS is a long-term cost system over the entire customer lifespan instead of a one-time acquisition cost. Therefore, CTS might shift simultaneously, directly affecting financial performance. For example, if a customer constantly returns purchased products, the CTS will soar, resulting in decreased profits.

In short, as you track how much customers are costing your business on a granular basis, you can get to the bottom line of profitability. CLV and CTS are effective metrics for evaluating the cost of acquisition and servicing a customer. Again, maintaining a good balance of revenue and expense is essential to business viability and profitability.

### Tips to Increase CLV

To increase CLV, you need to pay close attention to the components of the CLV formula. Indeed, the calculation of CLV comprises the average purchase value, the average number of purchases, and the average customer lifespan. Thus, boosting these factors altogether improves your CLV ultimately.

There are multiple methods to make your CLV rise, but they all come hand in hand with fostering customer relationships. In other words, customers with positive experiences tend to revisit more frequently and purchase more items in the long run. Consider the following tips to boost your CLV metric and generate more profits for your business:

1. Customer loyalty program: A well-planned loyalty program influences customers’ purchase frequency since it rewards customers who purchase within a timeline. Such a program can be a membership card or a point rewards system, helping you keep control of customer purchase value and the time a customer visits for their next purchase.
2. Customer experience investment: Investing in customer experience involves refining website visuals, call center operations, return policies, store design, checkout process, etc. A relevant approach to developing your customer experience increases the chance of revisits. Moreover, excellent customer experience also requires continuous reviewing of customer feedback to reflect and make appropriate changes to your business.
3. Customer relationship management: A Customer Relationship Management (CRM) system allows businesses to access communication history, including sales, marketing, and customer support. Therefore, building an effective CRM system is beneficial for monitoring and enhancing customer relationships throughout a customer's lifespan.
4. Social media adoption: Though traditional communication and management approaches still fulfill their roles, they don't make your business excel in the digital era. Instead of relying on unsolicited emails or cold calls, you can start putting efforts into your social media presence for potential customers. Social media also enables you to connect and interact with customers at a lower cost, resulting in profitability.
5. Data analysis software: You should employ software packages to centralize and analyze business data. Unlike the usual spreadsheets and databases, using advanced technology in data analysis is convenient and less time-consuming. Furthermore, it is a better method to ensure data confidentiality and assessment quality for improved business decisions directly affecting customers, such as product pricing.
6. Customer engagement strategies: You can apply upselling and cross-selling to encourage customers to purchase multiple items at more expensive values per order. For example, grouping complementary products into a bundle is an effective cross-selling tactic. These strategies help increase the average purchase value as well as the CLV.
7. Feedback loop resolution: Responding promptly to negative feedback helps prevent an increasing churn rate. A proactive approach to recovering customer satisfaction gives way to a long-lasting customer lifespan. As part of customer service, excellent negative feedback resolution empowers customer loyalty and strengthens customer relationships.
8. Onboarding process optimization: Take advantage of customers who have already made their first purchase with you rather than finding new customers. In particular, you can give customers special offers or selected deals within a few days of their first purchase. Customer onboarding helps you turn a one-time purchase order into a long-term customer relationship.

In this section, let's analyze the contributing variables of CLV. From a data-driven approach, understanding the components allows you to identify which factors affect the overall customer lifespan value. As mentioned above, the CLV formula is the average purchase value multiplied by the average number of purchases per year and the average customer lifespan.

Customer Lifetime Value = Average purchase value * Average number of purchases per year * Average customer lifespan

• Average purchase value: To calculate the average purchase value, you divide the total revenue by the total number of purchases during the same period, typically one year. This metric tells you how much money you earn from each purchase on average within the provided time.

Average purchase value = Total revenue / Total number of purchases

• Average number of purchases: The average number of purchases per year reflects the frequency a customer purchases your products throughout one year. Another name for this metric is the average purchase frequency rate. The formula is the total number of purchases divided by the number of unique customers during the same period.

Average number of purchases = Number of purchases / Number of customers

• Customer value: You can calculate customer value by multiplying the average purchase value by the average number of purchases during the same period. The customer value metric suggests how much each customer is worth to your business on average.

Customer value = Average purchase value * Average number of purchases

• Average customer lifespan: Average customer lifespan measures how long a customer relationship lasts, usually in years. To calculate this metric, you divide the sum of customer lifespans by the number of customers.

Average customer lifespan = Sum of customer lifespans / Number of customers

### FAQ

#### What is Customer Lifetime Value with An Example?

A local coffee shop collects data to investigate customer purchase habits and calculate the Customer Lifetime Value. The total revenue of the shop over the past year is \$100,000 from 20,000 purchase orders. The number of customers the coffee shop serves during the same period is 400. Since the shop has operated for a long time in the neighborhood, the sum of customer lifespans is 4,000 years.

Following the steps to calculating CLV, we first apply the formula to get the average purchase value. The result shows that each customer spends \$5 per visit.

Average purchase value = \$100,000 / 20,000 = \$5

Next, we continue finding the average number of purchases during the year by dividing the number of purchases by the number of customers. The result suggests each customer makes 50 purchases per year on average.

Average number of purchases per year = 20,000 / 400 = 50

The customer value for the coffee shop is the average purchase value multiplied by the average number of purchases. The metric displays how much money a customer brings to the business in one year.

Customer value = \$5 * 50 = \$250

To get the average customer lifespan in this scenario, we divide the sum of customer lifespans by the number of customers.

Average customer lifespan = 4,000 years / 400 = 10 years

Finally, using the formula for CLV and the above metrics, we get a value of \$2,500.

CLV = \$5 * 50 * 10 = \$2,500

#### How to Improve CLV?

To improve Customer Lifetime Value (CLV), businesses can use various strategies such as changing pricing, upselling, cross-selling, investing in a loyalty program or referral program, and improving their brand image. For instance, changing pricing or increasing the average purchase value can directly impact CLV. Investing in a loyalty or referral program can indirectly improve CLV by increasing the number of purchases per customer. However, these methods may come with additional costs. Another way to improve CLV is by establishing a strong brand image and providing exceptional customer experiences and high-quality products. This can lead to increased customer retention and better lifetime relationships.