Customer lifetime value or lifetime customer value (CLV or LTV) is the holy grail when it comes to measuring your return on investment with inbound marketing. It allows you to determine what each acquired customer is worth to your company over time, making it easier to plan your budget and revenue effectively if done right.
In short, it’s an important metric because it helps you determine how much you can afford to spend on acquisition and how much you should spend to retain each customer, but it’s also the basis of understanding the effectiveness of your inbound marketing. Of course, calculating customer lifetime value can seem like a chore, so we’re going to try and make it as simple as possible. We’re hoping by doing so, you can spread the gospel of CLV throughout your entire organization.
Ready? Here we go.
Figuring out your Customer Lifetime Value
First, you need to calculate a few variables:
Average Order Value
Average order value is the average of how much is spent on your site with each new order made. Makes sense, right? We’re going to look at each of these calculations over a year’s time.
Purchase Frequency
How many times a customer purchases from your business in a given time period. So, if you take the number of orders in the past year, divide it by the number of unique customers that ordered during that time period, you’ll get the number of times the average customer purchases from your site over one year.
Customer Value
Before we can get to the lifetime value of the customer, we have to calculate the customer value. This will tell you how much a customer is worth in raw dollars. The calculation for that is:
Customer’s Average Lifespan
This is a tough one to calculate and really depends on what type of business you’re in. For niche items that people generally buy once, the lifetime would be much shorter, and for something you buy regularly, like your favorite brand of jeans, it will probably be much longer.
Customer Lifetime Value
And now, the moment you’ve been waiting for. Here’s how you calculate the lifetime value of a customer. This will give you an estimate of how much revenue you can reasonably expect an average customer to generate for your company over the course of their relationship with you, which can help to streamline so much of what you’re projecting on the sales and marketing side.
This simple little calculation provides you with a lot to think about. If you have a high initial value but your customers are not staying around very long, one of the best ways to increase your revenue may be looking at your retention efforts. If the opposite is true, you may need to focus on new customers and upselling existing customers. The clarity you gain from this exercise is worth its weight in, well, customers.
Neil Patel created this great infographic when he was at Kissmetrics with an example of calculating lifetime value using Starbucks as a case study. We recommend pulling out the information that’s relevant to your business—which may not be selling coffee—and apply them.
Why calculate CLV?
Being able to calculate your LTV is important so you can make smart marketing and business decisions. By measuring LTV in relation to cost of customer acquisition (CoCA or CAC), companies can measure how long it takes to recover the investment required to earn a new customer.
This is an important calculation because it allows you to hold all members of your team accountable but also allows those in sales and marketing to better understand just how much their efforts are worth to the company. Getting everyone on the same page is a difference-maker for any organization.
You can take this one step further and figure out the LTV of different customer segments to streamline your marketing efforts to the ones that are most valuable to you. Determine what information they were seeking, create more of it, and automate a flow of information to keep them coming back again and again.
So, there you have it. If you’re still struggling to figure out how to calculate the lifetime value of your customers we’d be happy to help.
