What is Customer Lifetime Value?
Customer lifetime value is the net present value attributed to a typical customer in a company over their average buying lifetime. Moreover, this value helps to identify how much you should invest in customer retention. Knowing your retention rate, or how long a customer remains with you, is important for your customer lifetime value calculation.
In this way customer lifetime value represents the net profit that your company can make from a customer. This allows you to plan for the future, inform your annual budgets, and identify areas for improvement. This calculation could single out marketing campaigns that drive up costs, or highlight customer queries that cost too much time.
Customer Profitability and Lifetime Value
Furthermore looking at customer profitability and lifetime value is a great strategy to advise if a company is doing well. Look at the profitability level of each segment of customer in your database and match this to your customer lifetime value. Broken down by customer type you can identify segments that are less profitable than others. Now you can look at ways to improve the customer lifetime value of these segments.
How to Calculate Customer Lifetime Value
There are many different ways to calculate customer lifetime value. These formulas vary due to the age or size of a company, and also the data at your disposal. There is a simple ‘Average Revenue per User’ (ARPU) formula which predicts the annual value of a customer based off of a previous period. This can be a good starting point.
Customer Lifetime Value Formulas
There are three possible formulas that you can work from depending on the size of your business.
- Small Business With Limited Data: ARPU = Total Revenue / Number of Customers
- Small Business With Good Data: Traditional CLV = Gross Margin per Customer [Retention Rate (per month) / (1 + Discount Rate (per month) – Retention Rate (per month))]
- Larger Business With Good Data: Advanced CLV (1 month) = [Total Transactions x Average Order Value x Average Gross Margin x Average Customer Lifespan (Counted in Months)] / Number of Customers
Customer Lifetime Value Calculator
There are calculators available for free online but you still need to provide the information to perform these calculations. As well as this, because there are more than one formula for customer lifetime value you must find the right calculator for your business’ needs. This is why it is better to do these calculations in-house.
The Importance of Customer Lifetime Value
Using any customer lifetime value formula will give you the value of a customer to your business. The higher that value, the greater your profits. Knowing this value is important as you can enhance your marketing spend or hire less sales people. You can also identify if your pricing strategy is right, or you need to improve your customer retention rate.
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