Every customer is unique to your business.

They have different values and interests, different shopping and purchase preferences, and come from different economic backgrounds, demographics, and income levels. In an ideal world, we’d be able to devote 100% of our time to every single customer. Yes, every customer is important – and yes, every business tries its best to make sure their customers are well served and given the utmost care and attention.

But our time and resources are not infinite, and other priorities always arise in any workplace. Furthermore, there is a cost to acquiring your customer as well – whether you count a direct marketing campaign, or a call center operation, or even the hourly wages of your sales representative. So how do you know when a customer is worth the time and cost of gaining their business, and when another is not?

Enter the Customer Lifetime Value.

Customer lifetime value, or CLV for short, was first developed in the late 1980s as a new way for companies to calculate how much each customer would likely spend with the business over his or her lifetime. In short, it assigns a monetary value to each customer and tells you how much they are likely to spend based on their past purchase history, common demographic information, and the behavior of similar individual customers.

By rating their customers based on likely future spend, businesses can then focus their time and resources on cultivating their best customers and driving up sales. This is particularly important when you consider the classic Pareto principle that 80% of your revenue comes from the top 20% of your customers.

But wait – before you raise your hand, we’re not suggesting that you neglect the other 80% of your customers. Today, more than ever before, customers have various social avenues to express their satisfaction – or frustration – with your products and business, and it’s important to cultivate and serve your entire list of customers at every opportunity. A low CLV score should never be taken as an opportunity to offer poor service!

What CLV can teach you, however, is to be more efficient with your limited time and resources. Armed with the knowledge of a customer’s lifetime value, along with your own revenue goals and targets for the quarter, you can better deploy your sales representatives to ensure that you’re growing your business and providing the best service possible for your key customers.

What Customer Lifetime Value Tells You

So what are some ways in which CLV can help you?

Firstly, knowing the lifetime value of your customers allows you to segment your customer base into different groups and categories. The number and possible criteria of segments are endless – maybe it’s by number of purchases, likely total spend, or your top 1% of customers. With these segments in place, you can then allocate your marketing and sales resources more effectively to drive sales and optimize customer satisfaction. (For more on this, Dee Kumar has written an excellent guide on customer segmentation).

Knowing your customer’s lifetime value also allows you to break down tasks and responsibilities amongst your team to drive the best possible return. For instance:

  • Which customers get a personal phone call from the store manager despite the busy holiday season, and which ones just receive an email newsletter?
  • Which products and discounts are offered to different customers in the email newsletter that week?
  • Which customer’s difficult service request deserves that one-time exception, because they are likely to be a loyal and profitable customer in the long run?

All of these questions can be answered by knowing a customer’s lifetime value and predicted spend. Not only are you becoming more efficient with where you spend your resources, but you’re also improving the relevance of your products and outreach to your customers (for example, by showing them products that are likely to fit their spend amount for this holiday season).

How to Calculate CLV

Now that you know why the customer lifetime value score is useful for any business – how exactly is it calculated?

As with most analytics tools, the more information and fine-tuning that you add in, the more accurate your CLV will become. Furthermore, powerful analytics platforms (such as our own here at Canopy Labs) can help you calculate CLV based on even more variables, inputs, and purchasing trends. At its most simple level however, a customer’s lifetime value can be calculated by these basic inputs:

Average Purchase x Average Number of Purchases x Average Retention Time in Months or Years = Customer Lifetime Value

To put this to the test, let’s take an online store that sells phone cases and calculate their average customer’s lifetime value.

For simplicity, we’ll price all of the phone cases at $20 each, and assume that half of the customers make a purchase of 1 case, while the other half purchases 2 (making the average purchase order $30).

On average, each customer purchases 3 times a year. As for retention time, some customers will purchase once and never return to your store, while others stick around for years. For the purposes of our simple calculation, let’s say that the average time a customer sticks with your company is 3 years (a lot of 3’s going on here!).

Our basic customer lifetime value calculator would look like this:

$30 (Average Purchase Cost) x 3 Purchases (Average Purchases Per Year) x 3 Years (Average Retention Time) = $270 (Customer Lifetime Value)

So on average, your customers will spend $270 at your store over their lifetime.

What This All Means

Now that you know your customer’s lifetime value, you can decide how to reach out to your customers, how to retain them, and what to expect from your customers once they have made their first purchase.

This also allows you to get clever with your sales and marketing strategies. In this case study, it looks like the company’s biggest hurdle is actually acquiring new customers, who then seem quite comfortable making repeat purchases on their own. If that is indeed the common experience, then perhaps the company can offer a large discount on a new customer’s first purchase, since their lifetime value scores indicate that they will likely to purchase at least 10 more cases over the next few years. There’s no guarantee that this will lead to greater sales, – and there will certainly be some customers who make that first purchase based on a hefty discount and never return again – but your data from an entire customer base suggests that this is a good bet to make!

Furthermore, remember that customer lifetime value is not set in stone, but can be changed. Through smart marketing and sales strategies, you can convince customers to spend more over their lifetime and to reduce their likelihood to churn. So CLV is not just an indicator of what your sales will look like in the future, but can also act as a guide for where you should devote your energy to reduce customer churn and increase revenues.

For instance, which sets of customers are no longer becoming profitable to service (and should gradually be wound down)? In turn, which customers need an extra push to stay loyal, say through a membership or rewards program, but are worth the extra effort because of their higher lifetime spend?

Finally, an area that we have not spent a lot of time on, of course, is customer service and customer success. Above all else, the best way to increase your customer lifetime value is to ensure that your customers stick around – and do so willingly. The best sales and marketing tactics in the world will not improve your CLV if your customers constantly leave just 2-3 months after signing up with your business. And the only way to ensure that this is not the case is to invest your time, money, and effort into making sure your customers are satisfied with their product or service, and that their lives and jobs are made easier because of it. It will pay off in more ways than you could have imagined.

Ready to get to work? Collect your customer data, calculate your CLVs – and start getting smart about your sales and marketing strategies!

Learn more about CLV

The Intro Guide to Customer Lifetime Value is brought to you by Canopy Labs, a predictive analytics company. We work with businesses of all sizes to better understand – and sell to – their audiences. If you have questions about this guide or are interested in learning more about customer analytics, feel free to get in touch!

More Reading

We know we’re not the only ones who have written about Customer Lifetime Value. If you found this guide interesting, here are a few more links that might interest you!

Wikipedia – Customer lifetime value
KISSmetrics – How To Calculate Lifetime Value: The Infographic
ConversionXL – How To Calculate & Increase Customer Lifetime Value
Hubspot – How to Calculate the Lifetime Value of Ecommerce Customers

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