What is customer lifetime value?
Customer Lifetime Value (CLV) is the total value in revenue a customer represents to a company over the entirety of their business relationship or customer life cycle. It is one of the most important metrics to track for overall business performance.
The importance of measuring CLV
Customer Lifetime Value (CLV) can be one of the most important metrics for you to track in your business for a host of reasons. Three of the most important reasons to track CLV include, but are not limited to:
- Developing marketing strategy & measuring marketing performance
- Building effective revenue projections for your business
- Assessing your company’s valuation
Customer Lifetime Value (CLV) is sometimes used interchangeably with Lifetime Value (LTV), and is a current projection of future revenue. In the strictest sense, CLV is the present value of the future cash flows attributed to the customer relationship.
In the case of marketing, understanding CLV is possibly the most important metric that you need to understand in order to make both strategic and tactical decisions. When evaluating how your business is going to acquire new customers, and how much you are willing to pay to do so, it is essential that you understand exactly what a customer is worth to the business so that you are not exceeding that value with your marketing efforts. Quite simply, Customer Acquisition Cost (CAC) cannot be greater than Customer Lifetime Value (CLV). Remember, marketing is a driver of growth and revenue in a business, not a cost center. If your marketing efforts are not generating a profitable return on your investment, you are doing marketing wrong.
Customer LTV for repeat purchases
For example, assume that you run an e-commerce website and your average order value is $25 and your margin is 50%. If you know that on average a customer will return to purchase from you again 6 times over the course of the next two years, then you know that your CLV is $75. (($25 * 50%) * 6) = $75 Armed with this knowledge, you know that you can confidently spend $18.75 to make that first sale, even though $18.75 is greater than your profit on that initial purchase ($25 * 50% = $12.50), because that new customer will likely continue to purchase from you five more times over the next two years, resulting in Marketing Return On Investment (MROI) of 400%, which is a solid return on marketing investment.
Customer LTV for recurring revenue models
In the case of subscription-based companies, or recurring revenue business models, if a customer spends $10 per month and has an average lifecycle of 4 years, a 75% profit margin will result in a Customer Lifetime Value of $360. This means that as a marketer you can spend as much as $90 to drive that initial customer conversion of $10 and still see a 4x return on your marketing investment. This is one of the reasons that recurring revenue business models are so attractive for business owners and investors as it leads to a long-term relationship and supports a base of loyal customers.
Using customer lifetime value to develop marketing strategies
As an intelligent, data-driven marketer, knowing your CLV and comparing it to your Customer Acquisition Cost (CAC) is a smart way to evaluate the effectiveness and efficiency of your individual marketing tactics and channels. However, CLV also plays a critical role in strategic development, and this is where the power of customer segmentation really moves the needle for marketing performance.
Segmentation is effective in part because delivering marketing messages to specific & similar groups of consumers allows marketers to increase messaging relevancy and speak to unique consumer pain points. But customer segmentation also drives strategy when the concept of CLV is applied to understanding customer cohorts and what groups of customers a business should seek to acquire. Whether you are segmenting by demographic characteristics (such as age, gender or geographic location), firmographic fields (ie. industry, employee size or revenue), or behavioral factors (ie. recency/frequency of purchase), your segmentation matrix is incomplete without understanding which are your most valuable customers. When you have accurately identified your most profitable customers, you can focus your marketing efforts on attracting those specific customer segments, improving your likelihood of producing a positive MROI.
This critically valuable information can also inform business managers and product or service developers as they evaluate the future direction of the business. This kind of insight is at the heart of what is called consumer-centric marketing or marketing-led business development.
How to measure customer lifetime value
While this metric is typically expressed in terms of an average and based on past customer data, in certain circumstances it is used in one-to-one relationships and can be a fixed, known number, such as in contract sales or one-time purchases.
Lifetime value calculation
CLV = Margin ($) * (Retention Rate (%) / 1+Discount Rate (%) – Retention Rate (%) )
CLV = (ARPU ($) * Margin (%) ) / Churn Rate (%)
CLV = Revenue – (COGS + Cost of Services)
Customer Lifetime Value (CLV) is almost always calculated as the value after gross margin, or the actual profit attributed to a customer after the cost of delivering the service and the Cost of Goods Sold (COGS), the raw inputs that go into creating products. Sometimes CLV can include the Customer Acquisition Cost (CAC), how much must be spent on the process of acquiring a new customer, or a similar metric such as Cost per Acquisition (CPA), the average cost of acquiring a customer, into the calculation2. But in other cases, CLV is weighed against CAC metrics to evaluate the effectiveness and efficiency of marketing and sales efforts.