customer lifetime value formula

How to increase customer lifetime value – exact formula to drive CLV

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Definition of Customer Lifetime Value

Whatever type of business you have, Customer Lifetime Value (CLV) modelling is vital to understand the total worth that each new customer represents to the business. This can help provide a more realistic cost per acquisition, using this for future marketing initiatives and enabling a company to take a longer term view of its customer acquisition strategy. By understanding customer lifetime value, companies can also realistically discount products and services in a way that enables lower margins initially (by being more cost competitive) and longer term profitability.

When trying to calculate CLV, you need to take many things into account, depending upon the questions you need to answer.  The simplest way is to take the revenue earned from a customer and take away form it the money spent acquiring and looking after them.  If you don’t want to get bogged down with an in-depth and long-winded customer lifetime value analysis, here is one that you can do it very quickly:

Take the value of an average order within your business = say $50
Assume that every time an order is placed, there is a 10% change customer will repeat.
Also assume cost of acquiring customer = $15

So average order value divided by one, minus the repeat purchase rate, or $50 / (1 – 0.1) = $55.56.  Now take away the customer acquisition cost from that, and you get a CLV of = $40.56 so this is your answer.

You can work out the CLV historically, over a set period of time or use it to predict values; predictive CLV is a great way of looking at what a customer is worth now and in the future.  You can also work at ways to improve your CLV.

Understand the value of each customer

Not all customers have the same value so knowing which ones to focus on is essential if you are serious about boosting profits.

We have already seen from the example above how to calculate a basic CLV.  This can also be defined as the amount of profit generated per customer over the period of time of their account being with you.  Once you know the CLV of each customer you know which ones are the most profitable and can begin to segment your customer base accordingly, focusing marketing, product development and retention efforts to match.

There are also many online tools that can calculate this CLV for you.  Once you get the hang of working out the CLV you can change the numbers and see how it might improve if you increase the number of purchases in one year or reduce marketing costs.

Steps for calculating the value of each customer

So how do we calculate the value of each customer in more detail?  Follow these simple steps:

Step 1: Calculate the profit contribution of each customer in the current year.
This has to be revenue per customer less costs (cost of goods, amount to service etc.)

Step 2: Develop a realistic estimate of how long you might retain each customer.
This is based upon how often they will repeat their purchase and remain with you.

Step 3: Estimate the cost to acquire or retain the customer.
Add up the costs of all marketing per year as well as things like discounts.

Step 4: Do the calculation.

Now you can build your own formula, remembering to allow for overheads/operating costs.  You should also discount future years at a cost per capital (say 8%).  It will look something like this:

100% divided by (100% minus the annual retention rate)
OR (1 / 1- annual retention rate)

Now we have all the inputs into the simple customer lifetime value formula, we can then calculate CLV as:
CLV = (profit) X 5 (years) – (acquisition) = total CLV

5 strategies to increase CLV

There are many things that you can do to increase your CLV.  Here are just 5 strategies that you can bring into play:

  1. Building long-term relationships is a great way of increasing revenue whilst keeping expenses low:
    1. Always be honest – look after your customers, no matter whether you have to take a reduced sale or even lose them to someone else. By focusing more on looking after them than following the money, they will see you as being far more altruistic with higher standards.
    2. Share – share your skills and knowledge with them for free, boosting their confidence in you whilst making them aware of additional products.
    3. Be a partner – create a strong relationship that is mutually beneficial and builds trust. Keep your customer for a lifetime by referring their services and even use their products.
  2. Create brand loyalty

Don’t listen to anyone that says brand loyalty is dead.  Look at Apple, a key leader when it comes to brand loyalty due to their quality, value and high level customer service. Brand loyalty increases CLV as buyers will try new products, repeat purchase and increase their lifetime with you.  Three key factors influencing brand loyalty are: quality, customer service and shared values.  Use your company mission statement to demonstrate your values.

  1. Always upsell and cross-sell

This allows you to increase the amount per sale, pushing up the lifetime value of an account.  When you upsell you increase the value of the same product; when you cross-sell, you add additional products to the equation.  However, you must always be honest, referring to targeted information.  Continually pushing unrelated products will damage your credibility.

  1. Choose the right rewards and incentives

Use an incentive that holds customer attention, promoting loyalty and increasing profitability.  You won’t do this by offering discounts so instead use exclusive offers or value-added rewards. Studies have shown that the lifetime value of customers acquired via discounts in lower than those attracted in other ways. Discounts also reduce the perceived value of items so use freebies instead, maintaining the image of quality.

When choosing your incentive, you must always:

  1. Communicate to raise awareness – tell customers about incentives
  2. Ensure rewards are attainable – they need to be engaging, high value and equitable with those offered by competitors.
  3. Make them complimentary – it must match your brand.
  4. Use free gifts – these can be used as rewards and help to cross-sell.
  1. Use multiple touch points to deliver superior customer service

Research has shown that 56% of customers will switch to another provider if they offer more ways of connecting.  Always maximise your channels of communication i.e. meetings, phone, web, social media, etc. but do remember that whilst 60% of consumers don’t want to receive a phone call about special offers, 75% prefer to be told via email or text.

Do all of this and you will increase customer lifetime value and increase revenue. By upping your CLV, loyalty is increased along with profitability.

15 ways to increase CLV with examples

So how can companies increase CLV?  Here are just 15 ways that you can put into practise:

  1. Personalisation – a recent report showed that 94% of businesses feel that personalisation ‘is critical to current and future successes’. At the same time, 66% of clients cited improved business performance and customer experience as key drivers for personalising customer website experiences i.e. Amazon; content is tailored to suit previous shopping/viewing behaviour, even showing customer name.
  2. Don’t charge for returns – whilst there are cost involved, free returns need to be judged against extra conversions and the boost of retention rates. Research has shown that clients that make frequent returns are often top customers i.e. expensive shoes can have a 50% return rate.
  3. Fitting tools and virtual wardrobes – this can help to reduce fit-related returns of products.
  4. Give precise delivery times and keep to them – don’t extend delivery slots and waste customer time. Offer to deliver to a work address or text customers to give a delivery window.
  5. Provide multichannel returns – providing a facility for returned items to be taken back to a local store is vital. Whilst customers are in store, you can also provide great customer service or even upsell/cross-sell. Customers love this added flexibility.
  6. Surpass customer expectations – take a leaf out of Amazon’s book who frequently come out tops in customer satisfaction surveys; fulfil orders on time and beat delivery dates.
  7. Reward loyalty – give rewards or some kind of exclusivity to strengthen brand affinity i.e. responding to a Tweet or creating an online club.
  8. Excellent customer service – Zendesk found that consumers rank quality and customer service highly, standing at 88% and 72% respectively. Providing best customer service 24/7 was also rated as a top requirement, coming in at 34%.
  9. Get the packaging right – make it stand out for all the right reasons. Birchbox include a beautifully written letter in a branded box created from Birch trees.
  10. Persuade customers to register – if you can persuade customers to do this, the benefits are many; they can track orders, get special offers and repeat purchases easily as well as saving payment details.
  11. Improve email customer service – this is the favoured channel for communication, standing at 44%.
  12. Offer useful apps/utilities – mobile apps are extremely popular, saving customers time. A recent report found that mobile/online banking ‘delights’ customers.
  13. Post-purchase emails – send a welcoming email and maybe some cross-sell ideas.
  14. Reward your most valuable customers – look after your top customers by offering things such as priority despatch, first choice of new products, personalised shoppers in-store.
  15. Offer exclusive deals for social followers – maybe exclusive sales to Facebook followers; give them reasons to keep coming back.

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