Acquiring a new customer can be both time-consuming and costly, so you certainly want to keep each and everyone that you get. Put another way, when compared to new business, repeat business is far easier and requires significantly less overhead. This is why customer lifetime value (CLTV) has become such an important measure in the world of marketing. By precisely identifying and understanding your CLTV, you can ensure that the cost of acquiring new customers doesn’t ultimately outstrip the revenue that you will generate from those customers. But exactly what is considered customer lifetime value, and how can you calculate it?
Briefly defined, CLTV is an estimation of the total income that you can expect from a new customer over the entire course of your relationship with that customer. Companies can employ CLTV to determine appropriate marketing expenditures with an overall return on investment (ROI) in mind.
How to Calculate Customer Lifetime Value
Although its simplicity is partially misleading, the basic equation that underlies the CLTV criterion is both succinct and elegant. Essentially, CLTV can be calculated using the following customer lifetime value formula:
CLTV = Customer Value (CV) x Average Customer Lifespan (ACL)
Like E = mc2, this equation is both short and sweet. It becomes more complicated quite quickly, however, when you begin to calculate its contingent factors.
Although more straightforward than customer value, average customer lifespan (ACL) requires a considerable amount of research and analysis to determine. In short, ACL is the average number of years that a typical customer continues to purchase goods or services from your company. In most cases, the following equation is the easiest and most accurate way to determine overall ACL:
ACL = The Total Sum of Your Customers’ Lifespans ÷ Your Total Number of Customers
The other critical factor in the general CLTV equation, customer value (CV) is configured by multiplying your customers’ average purchase value by their average purchase frequency rate, as in:
CV = Average Purchase Value (APV) x Average Purchase Frequency Rate (APFR)
To calculate your average purchase value (APV), you must divide your total revenue generation over a specific period of time (typically one year) by the total number of orders made over that same period. This produces the following equation:
APV = Total Revenue ÷ Total Number of Orders
To calculate your average purchase frequency rate, (APFR) you must divide your customer’s total number of purchases over a specific period of time by the total number of customers who made unique purchases over that same period of time. This produces the following equation:
APR = Total Number of Purchases ÷ Total Number of Customers
Retaining Customers Is Important
According to The European Business Review, it is generally five times more costly to acquire a customer than it is to retain them. An influential study by Bain & Company echoes these sentiments, positioning customer retention as the key variable within the overall consumer lifecycle. In fact, the study concluded that a 5% retention rate increase can yield profit increases as high as 95%.
These statistics demonstrate just how important it is to devote company resources toward retaining the customers that you have. By calculating your CLTV you can make sound asset allocation and general business decisions knowing full well how much your long-term customer relationships are worth.
Benefits of Customer Lifetime Value Calculation
An obvious advantage of CLTV assessment is its ability to cut overall customer acquisition costs by ensuring that the upfront expense of each acquisition will yield acceptable ROI over the long term. This is particularly important in light of the considerable marketing resources that are required to attract and convert new customers.
Whether you place a precise dollar value on it or not, your CLTV exerts a profound influence in the business world. Here are just a few ways that CLTV can spell success or failure for your company.
CLTV allows you to identify the specific customers most likely to return for repeat purchases over the long term. As exemplified by the statistics above, repeat business by existing customers is an incredibly powerful force when it comes to the overall generation of revenue. Use CLTV to boost customer retention by attracting optimal prospective consumers and keeping existing customers happy with the particular products and services that they prefer.
You can’t get the most out of your consumer prospects if you don’t know which consumer prospects to target. By taking care to calculate your CLTV, you can separate a customer who will buy only one or two relatively inexpensive items from your company from one who will make major purchases on a regular basis for years to come. With this knowledge foremost in mind, you can develop products and marketing strategies that specifically appeal to the customers who will be highly profitable to your business.
Influences Customer Loyalty and Retention
CLTV assessment has tremendous potential to increase overall customer loyalty and retention. Any company that stresses the total value of long-term consumer relationships will strive to provide value to its existing customer base, knowing full well that these efforts are far more affordable than those that are required to attract and acquire new customers.
Effective customer loyalty and retention initiatives range from comprehensive service and support operations to designated customer loyalty programs. In addition to slashing your customer turnover rate, superior customer loyalty and retention efforts led to more positive company reviews and personal consumer referrals.
Partner with a Leading Digital Marketing Company
Figuring out how much you can earn from the entirety of a customer visits to your business can seem overwhelming. You can also use our Customer Lifetime Value Calculator, below, and have it do the math for you.