The Importance of Customer Lifetime Value for Your Business

Businesses today face a growing challenge: it’s becoming exponentially more difficult and expensive to both attract and convert new customers. 

For this reason, many marketers and managers are shifting their focus towards understanding how they can increase the retention of their existing customers, rather than just running continually on the new customer treadmill.  

One of the most effective ways of measuring how profitable it is to retain a specific client is by determining their Customer Lifetime Value (or CLV) to your business. 

Let’s explore the concept of Customer Lifetime Value and discuss how you can use it to make smarter business decisions. 

What is Customer Lifetime Value? 

Customer Lifetime Value represents a customer’s potential value to your company throughout their time as an active customer of your brand. In its simplest form, your business’ CLV can be calculated by multiplying your Average Customer Profit with your Average Duration of Customer Retention. 

In 2018, research conducted by Criteo found that 100% of the marketers they surveyed were aware of the term “Customer Lifetime Value”, yet only a third of them understood what it meant. This indicates that many businesses are yet to utilise CLV calculations as part of their decision-making process. 

This is unfortunate, as it isn’t complex to calculate CLV, and it can provide key insights into which types of current customers are the most valuable to invest in, as well as build strategies to improve CLV. 

How to calculate Customer Lifetime Value 

There are several ways to more accurately calculate each customer’s CLV, but the basic rule of thumb is to break it down into different KPIs.  

Here’s one example using four KPIs: 

• Average Order Value (AOV) 

• Purchase Frequency (F) 

• Gross Margin (GM) 

• Average Lifespan using Churn Rate (Churn)

With these, the formula you need to calculate CLV is: CLV=AOV*F*GM*(1/Churn) 

Take a look at this example 

Let’s say you have a customer that spends $2,500 each quarter and your gross margin is 20%.  

This means that every year, you are making a gross margin of $2,000 ($2,500 x 4 x 20%) from this customer, which you can then weight with your average churn rate.  

Your churn rate is the percentage of customers that stop doing business with you each month/year (use the appropriate timeframe you’re using with the other metrics). 

If you have a high churn rate, then your business will be losing a significant number of customers, and therefore your overall CLV will reduce. However, if your customers typically stay with you for longer, then your CLV will be much higher. 

Let’s assume your churn rate is 20% (you lose 200 out of 1,000 customers in a year). The formula is $2,000 x 5 (1 / 20%), so $10,000 per customer. So the 200 customers that you lost were worth $2 million!

How can you improve your Customer Lifetime Value? 

Once you have an understanding of your CLV, there are several ways you can improve it, simply by focusing on your KPIs. 

A great starting point is to segment your customers into different tiers based on their individual CLV and then develop targeted marketing strategies for each customer group. 

For example, to learn more about your top tier or highest value customers, you could: 

• Schedule impromptu calls through your outbound call centre to make sure they are happy with your services and discover how you could provide even more value to them. 

• Surprise and delight a handful of your top customers each month with a reward and ask them to provide feedback via a survey or social media channel. This is great for your brand awareness. 

For those customers that are not at the very top of your CLV tiers, the aim is to improve their KPI metrics, such as putting together strategies to increase their purchase frequency or the amount they spend. You can do this by: 

• Building personalised product recommendations and newsletter campaigns. This can be done using the output of a basket affinity analysis (want to know more about this concept, talk to us). 

• Implementing dynamic communication and reengagement strategies with customers that haven’t made a purchase in some time. To do this, you need to determine the time period that you’d like to use for your “lapsed” group, such as 12 months since their last purchase. This period will be heavily dependent on your type of product and industry. 

• Adjusting your recommendation model for returning customers to help increase the sales of your higher-margin products. 

Your churn rate is another key area that you can focus on

Your churn rate can be improved by using predictive models that help you understand when a customer is likely to “churn”. Doing this allows you to implement preventative measures and proactive retention strategies (we have a great case study on this).

Incorporating your Customer Acquisition Cost (CAC) 

As your Customer Lifetime Value evolves over time, a great way to track your progress is to measure it as part of a ratio against your Customer Acquisition Cost (CAC). 

Your CAC can be calculated by adding up your marketing and sales costs, as well as the costs associated with bringing on and servicing a new client, and then dividing this total by the number of new customers you have gained, across a certain timeframe. 

If you have a healthy business, your CAC will be lower than your CLV. If this is not the case, then you need to take a thorough look at your business to determine where you can make adjustments to improve your CLV to CAC ratio. 

Key takeaway: the essential element is data 

Whatever approach you may take (and there are many), you can see that data is the key to uncovering these business-critical insights. With the right data collection and analysis processes, you can make more informed decisions about how to improve revenue generation, margins and more, all to improve your Customer Lifetime Value. 

If you are not collecting the right data or you are not sure how to use it, then you’re foregoing significant opportunities around potential business growth. 

That’s where White Box comes in. 

Do you need help measuring and improving your Customer Lifetime Value? 

At White Box, we collaborate with businesses like yours to help you understand your Customer Lifetime Value and identify how you can improve your KPIs to increase customer retention, efficiencies and profitability. 

If you would like to learn more about how you can use data to empower your Customer Lifetime Value decisions and strengthen your business, start a conversation with us today. 

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