Customer lifetime value (CLV) is one of the most important metrics for a marketing organization and its strategy. CLV measures the value of your customers over time, providing meaningful insights on why, where, and how you should conduct your marketing campaigns.
CLV also ties in closely with customer retention because it helps you understand how healthy your business is long term based on the value of your customers and, more importantly, how much your organization should invest in retaining each customer to grow a profitable business in the long term.
Why Measure CLV And Retention?
If your goal is to build a sustainable business for the long haul, looking at short-term revenue or making a quick buck off of people just won’t cut it. At the same time, though, spending a ton of money on each customer in hopes that he’ll keep buying isn’t good for business either. While it isn’t ideal to just have one-off customers, you don’t want to pamper and pull out all the stops for every individual who walks through your doors if some are only going to buy from you once (if at all).
Measuring CLV and customer retention can help. By analyzing these two metrics, you can figure out the value of your customers throughout their entire life cycle and identify which ones are worth retaining. It also lets you determine how you much you should spend on customer acquisition and retention to ensure that you’re profitable.
How To Crunch The Numbers
There are a number of ways to measure CLV and retention. Companies have developed many algorithms and equations to calculate it, depending on the numbers and nature of their businesses. Generally speaking, you need to look into several factors, such as customer lifespan, profit margins, average spend per purchase, number of purchases per year, and projected revenue.
Management Accounting Quarterly shares one approach using three main components: contribution margin, marketing cost, and probability of purchase in a given time period. Its equation goes as follows:
Recurring revenues – recurring costs = gross contribution margin – marketing costs = net margin x expected # of purchases over next three years = accumulated margin – acquisition costs = CLV (adjusting for NPV).
According to the publication, companies can apply this approach to measure CLV and “rank customers on the basis of their contribution to profits.” It adds that calculating the CLV would help businesses develop and implement strategies specific to each customer in order to maximize their lifetime profits and lifetime duration.
Other companies have a slightly more elaborate approach. For instance, a case study conducted by KISSmetrics about the world-famous Starbucks uses three common customer lifetime value equations and arrives at the CLV by averaging the answers of all there. Here’s a look at those equations:
Each equation would give you three different amounts, so in order to arrive at one CLV, all you need to do is average the three.
On the other hand, you can also make use of online tools that calculate CLV for you. Harvard Business School, for example, offers a Customer Lifetime Value Calculator that incorporates average spend and number of purchases, direct marketing costs, average gross margin, annual discount rate, and average customer retention rate.
By using this calculator, you will be able to get your estimated revenue per customer, one-time acquisition costs, profits per customer, and more.
Alternatively, opting to measure your CLV with the help of marketing and/or data companies can potentially give you deeper and more actionable insights about your customers.
At Retention Science, for example, we analyze all of the above-mentioned factors together with each customer’s demographic and psychographic data and online behavior. Doing so allows us to not only measure, but also predict, their lifetime value and retention rate, as well as provide actionable insights that companies can put to work.
What To Do With CLV And Retention Insights
Once you’ve calculated your customers’ lifetime values and retention rates, it’s time to make sense of those numbers and take action. To make things easier, we recommend segmenting your customers based on the value they bring into your business.
You can group customers depending on the frequency of their purchases, the amount of revenue they bring in, and the number of purchases that they’ve made. So, for instance, when looking at customers based on the revenue they’ve generated, segmenting them would look something like this:
After grouping your customers, the next step is figuring out how to uniquely engage each segment. Your marketing strategies should obviously vary depending on the type of customers that you’re dealing with, so be sure to create distinct campaigns for each group.
And in order to make your campaigns more personalized, you could also consider further segmenting your customers by grouping them based on their demographic information. Aside from deciding the types of campaigns to implement, grouping your customers based on their value also allows you to determine how much you should spend on each group to maintain profitability.
Moreover, segmenting customers based on the revenue they bring in can help you find out where your high-value customers are coming from. Going back to the chart above, if you wanted to acquire more customers who would bring in $1,000 and up, then you can look into the demographic and behavioral data of that particular segment.
What age and income bracket do they fall into? Where are they located? How did they find you? Use the answers to these questions to fine-tune your campaigns and acquire more of the same types of customers.
Test And Revisit The Numbers
Measuring CLV and customer retention isn’t something that you do once or sporadically. Be sure to track and test the campaigns to see how effective they are in converting each customer segment. Additionally, it’s important to continuously monitor these numbers and create or modify your marketing strategies accordingly to ensure that each marketing campaign yields greater results than the previous ones.