How To Calculate Customer Lifetime Value to Drive Strategic Decisions

One of the biggest challenges that marketers face is justifying their investments. How much should your business spend to acquire a new customer? If you spend too much, you’ll eventually go out of business. If you don’t invest enough, you might be missing opportunities to grow – much to the delight of your better-informed competitors. The stakes associated navigating this dilemma are pretty high. Forecasting future cash flows by calculating customer lifetime value is an essential practice in figuring out how to invest in your ideal customer. The lifetime value of a customer calculation is an essential, “Executive Metric” for managing your business.

Your investment in acquiring a new customer, like any investment, should be less than the value that a single customer returns to your business. But how do you determine what value a customer will bring to your business in the future? This brings us to one of the most important executive KPI’s (key performance indicators), Customer Lifetime Value or CLV (Try Our Online CLV Calculator). Just as it sounds, CLV is a powerful measure that estimates the future value of a typical customer over an average customer relationship lifespan. Improving CLV can make a big difference on the bottom line, but first, you need to have some visibility into the various factors that influence the measure.

At the most basic level, CLV can be calculated by determining an average customer’s cash flows (or profits) over the lifetime of your business relationship, less the costs to borrow money to invest in your business and the initial costs to acquire the customer. Let’s assume that an average donut-buying customer spends, on average, about $10.00 per transaction (averaging the purchases of many customers) and the average profit margin over food costs are 80% (yes, 80%). Let’s use historical data to measure how frequently an average customer visits the donut shop (twice a month) and the average lifespan of the relationship (3 years).

The average customer, using the most basic CLV calculation is worth $576. That’s a lot of donuts.

If you want to take things a step further, you can also include two other important factors, a) the average retention rate, and b) the current discount rate or the average cost of capital. These measures will help you understand today’s value of a typical customer.

Variables:

  1. Average Purchase Cycle: e.g Daily, Weekly, Monthly, Yearly
  2. Average transaction value
  3. Average number of transactions per purchase cycle
  4. Average lifespan of customer Years
  5. Average retention rate = % of customers you retain each purchase cycle
  6. Average profit margin
  7. Current discount rate. This varies between 8% and 15%, but you can use 10% to start.

Formulas

Simple: a (365, or 52, or 12, or 1) x b x c x d
Advanced CLV: Above Answer x (e / 1+g-e) – less costs to acquire.

customer lifetime value CLV

 

Key benefits of understanding your customer lifetime value

Market Segmentation

You can determine which customer groups are more profitable and adjust your investments, priorities, and strategies accordingly.

Marketing Investments

You can optimize your acquisition strategies to leverage the ones that drive the most profitable business. That doesn’t necessarily mean the lowest costs, but the combination of factors that lead to the optimum number of new, profitable customers without over OR under investing.

Product Development

Enhancements to your offering, inclusive of products and services, may result in increased retention and expanded purchase volume. Pricing is also an important factor. Optimizing your product assortment or perceived value might command higher prices with the right segments.

Finance

What kind of difference would it make in the profitability of your customers to be able to borrow at a highly competitive rate?

Calculate Customer Lifetime Value Online

Measuring and continuously monitoring CLV can help business owners evaluate financial performance, relative to their acquisition costs. Understanding the different metrics that contribute to your CLV can provide valuable insights about strategies and priorities that can help justify your marketing investments and make an impact on your bottom line. To get started, download the CLV resource guide, and try our online CLV calculator.

Download LTV resource guide

Looking for More Insight About Growth?

If your current efforts aren’t delivering the kind of results that you need or expect. Maybe it’s time for a change? We recommend starting your own investigation by taking our Free Growth Score assessment to help you figure out whether or not you have the infrastructure in place to grow quickly. A Growth Consultant can review your report with you and make specific recommendations that are tailored to your unique situation and your category to help you figure out the priorities that will create the biggest and fastest impact on your bottom line.

A conversation is always free. We’re here to help, so we encourage you to reach out to start a conversation about ways to optimize and scale your growth.

Peter Wyro, MBA

Peter Wyro, MBA

Chief Growth Officer. Peter has led international marketing and product development teams which have resulted in more than $100 million in revenue and asset value creation. He earned a Bachelor of Fine Arts Degree from the University of Texas at Arlington and an MBA from the University of Dallas, Graduate School of Management. Proud father of two awesome daughters.

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