Customer Lifetime Value (CLV or also LTV) is a metric used in business and marketing to estimate the total revenue a business can expect to earn from a customer throughout their entire relationship with that business. Calculating CLV is important because it helps companies understand the long-term value of their customers and make informed decisions regarding customer acquisition and retention strategies. For example, if you understand your CLV it may be that the biggest initial purchasers of your products never purchase again but customers that make small purchases will buy more from you over time. Knowing this, you can adjust your marketing strategy to get more of the type of customers you want.
The formula for calculating CLV can vary depending on the specific business model, but a basic formula for CLV is:
CLV = (Average Purchase Value) x (Average Purchase Frequency) x (Average Customer Lifespan)
Here's a breakdown of each component of the formula:
Average Purchase Value: This represents the average amount of money a customer spends in a single transaction or order. You can calculate this by dividing the total revenue from all customer purchases by the number of purchases made by all customers.
Average Purchase Frequency: This is the average number of purchases a customer makes over a specific period (e.g., a year). It is calculated by dividing the total number of purchases by the number of unique customers during that period.
Average Customer Lifespan: This is the average number of years a customer continues to do business with your company. To calculate this, you can take into account the churn rate, which is the percentage of customers who stop doing business with your company in a given period (e.g., a year), and then use the following formula to determine the average customer lifespan:
Average Customer Lifespan = 1 / Churn Rate
Customer Churn Rate: The customer churn rate is the percentage of customers who stop using a product or service over a specified period. To find the customer churn rate, you typically use the formula:
Churn Rate = (Customers Lost during a Period / Customers at the Beginning of the Period)× 100
Once you have these three components, you can plug them into the formula to calculate the CLV. Keep in mind that this is a simplified formula, and in practice, CLV calculations can be more complex, especially for businesses with more intricate customer behavior and purchasing patterns.
Calculating CLV is essential for making informed decisions about marketing budgets, customer acquisition costs, and customer retention efforts. It helps businesses determine how much they can invest in acquiring and retaining customers while ensuring profitability over the long term.