Customer Lifetime Value (CLTV)
Customer lifetime value (CLV) represents the total amount of money a customer is expected to spend in your business, or on your products, during their lifetime. CLTV is an important metric that helps you make decisions about how much money to invest in acquiring new customers and retaining existing ones.
For instance, if a customer continues to buy products or services from your business for 10 years and spends $10 per year, his or her customer lifetime value is $100, minus any money you spent to acquire that customer.
How to calculate CLTV?
CLV = [Average value of a purchase * Number of times the customer will buy each year * Average length of the customer relationship (in years)] - (Cost of acquiring and serving the customer)
Example: Imagine you are selling shoes from an e-commerce platform. You spent $10 in advertising to attract a customer. The Customer continues to buy an average of 2 shoes per year for the next 10 years. Your profit margin on each shoe is $10. You will generate a profit of $200 from the customer over the next 10 years. If we subtract the cost of acquiring the customer, you’ll get the net customer lifetime value of $190.
Here is another way to calculate CLTV using Average Customer Lifespan(ACL):
Step1: Calculate Average Order Size (AOS)
AOS = Total Revenue / Total # of orders
Step2: Calculate Average Order Frequency (AOF)
AOF = Total # of orders / Total # of Customers
Step3: Calculate Average Customer Value (ACV).
ACV = AOS / AOF
Step5: Calculate Average Customer Lifespan (ACL).
ACL = 1st Order Date - Last Order Date
Finally Customer Lifetime Value (CLV) = ACL / ACV.
Importance of CLTV?
Calculating the CLV for different customers helps in a number of ways, mainly regarding business decision-making. Knowing your CLV you can determine, among other things:
How much you can spend to acquire a similar customer and still have a profitable relationship: It means if you estimate one customer’s CLV to be $500, you wouldn’t spend more than that to try and keep the relationship. It just wouldn’t be profitable for you.
It’s a faster path to additional revenue through retention: The best way to maximize customer lifetime value is by investing in retention. For example, for every 1% of shoppers who return to your e-commerce site after their first visit, your revenue increases by approximately 10%. So if you retain 10% more of your existing customers, your revenue effectively doubles.
It helps you analyze the kind of products customers are attracted to: The customers with higher CLTV also give insight about the product. If more number of customers having higher CLTV buys a similar product, that means that the product is delivering good value for the customer’s money.