What is Customer Lifetime Value and Why You Should Care

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what is customer lifetime value

I bet you are doing a great job measuring your business success.

Most likely, you check up on your basic online store metrics frequently. There are about 30 key performance indicators for an e-commerce business you should be looking at. All of them are necessary and point out milestones on the road to your online success.

Among others, ROI is the essential factor to focus on while evaluating your overall performance. However, just bear in mind that it gives you a slightly short-sighted business perspective.

And then there’s also customer lifetime value.

In fact, building better relationships with your clients actively contributes to improving ROI. And this is precisely where customer lifetime value comes in.

Heard of it yet? Do you pay enough attention to it?

I’m asking because Econsultancy reports that just 42% of companies can measure their CLV. So, if your grasp of customer lifetime value seems to be little blurry, definitely keep on reading.

In this article, I’ll try to introduce this vital quality indicator to you. I will use simple words to let you take it from here and put in place right away at your organization. Also, you’ll find a piece of advice on how you can improve CLV efficiently.

Let’s begin.

What is Customer Lifetime Value

Here’s the most straightforward way to define it:

In marketing, customer lifetime value or CLV is the value of a given customer reflecting his contribution to your business. Roughly CLV is the projected revenue that a customer generates in a lifetime.

It determines the net profit attributed to the entire future relationship with customers. It gives you a perspective on where to invest your resources and what customers are the most valuable to you.

Customer lifetime value is one of the metrics that matter most for the present and future success of your e-commerce business.

And you actually can’t afford to ignore it. Without knowing your customers’ value, you simply won’t have any idea where to head next. It’s like losing your orientation in the woods not having a compass with.

Customer Lifetime Value Formula Made Simple

Once you understand how customer lifetime value is calculated, a great new world will open to your eyes. You’ll finally see how much time your customers spend at your online store and how often they do it.

The customer lifetime value formula can vary in sophistication and accuracy. It depends on the variables used.

The math can get a little complex here and look like this:

customer lifetime value formula

But because simplicity is the highest form of sophistication, we’ll take the easy way. The most uncomplicated mathematical formula for calculating the lifetime value of your customers:

[(Average Order Value) x (Purchase Frequency)] x (Average Customer Lifespan) = CLV

*(Average Order Value) x (Purchase Frequency) = CV

Bear in mind that resources available online use various nomenclature. So don’t be surprised when you come across different names for the same thing.

For the sake of better understanding this formula, we’ll illustrate it with an example.

Kissmetrics released a relevant infographic that breaks down every step of the calculation. They’ve used Starbucks data in LCV context so that we can base our simple calculation on these numbers.

What Variables You Need to Calculate Your Customer Lifetime Value

Before you calculate CLV first dive into your variables and find averages.

customer lifetime value variables

1. Average Order Value

The first average represents the customer expenditure per visit across 5 exemplary clients. Starbucks customers spent respectively $3.50; $8.50; $5; $6.50; $6 per visit. The result is $29.50 divided by 5 customers gives us an average order value of $5.90.

2. Purchase Frequency

The next variable is purchase frequency (within a week) in other words ‘purchase cycle’. According to the example, the first customer visited Starbucks 4x during one week, the second 3x, third 5x, fourth 6x and the last one 3x. This gives us 21 visits total divided by 5 results in the purchase frequency of 4.2.

3. Average Customer Value

*(Average Order Value) x (Number of Repeat Sales) = ACV

Now comes the average customer value that is the combination of the average order value and purchase frequency per week.

In this case, we calculate this measure for every single customer individually, and then we sum up results and divide by 5. The average customer value in this example is $24.30.

Finally, we have all averages beautifully estimated. Now we can plug variables into the CLV formula and multiply it by the average customer lifespan.

($24.30) x (Average Customer Lifespan) = CLV

4. Average Customer Lifespan

The very last element of customer lifetime value equation tends to be the hardest one to measure accurately. This metric is the average time a given customer stays with a brand. In other words, customer keeps on coming back to your online store, before gets dormant and abandons you forever.

Avinash Kaushik recommends using a number of 1-3 years as an average lifespan for a typical consumer e-commerce player. However, this part obviously depends on the niche your e-commerce business operates in.

If you sell clothes online then possibly your customers remain active for 3 years. For instance, Starbucks reports that their average customer lifespan reaches 20 years ;-). So just imagine how this equation applies to this example.

The calculation for Starbucks we recreated applies to one week. This is why if we want to see Starbucks’s CLV, we need to multiply the results by 52 weeks (because the year breaks down into 52 weeks):

[52 x $24.30] x 20 years = $1263,6 x 20 years = $25 272

Yeah, Starbucks CLV = $25 272. Impressive, huh?

Have a look at the screenshot from KISSmetrics infographics.

ways to calculate LTV

Companies like Starbucks deploy more formulas to calculate this indicator to get the average right.

Okay, that’s enough math for one day.

What’s important is that the Starbucks example hasn’t been given without reason.

If you take a closer look at Starbucks, then you’ll understand one fact. This company cares about their customers. And does what’s takes to keep the present customers and continuously acquire new prospects of the highest business value.

It’s no more about selling this single cup of coffee. It’s much more than that. Starbucks takes a data-driven approach that lets them continuously increase their bottom line.

And this translates to:

  • Providing excellent customer service of reps who listen to and care for customers.
  • Constant improvement of the environment a customer spends time in, making it as comfy as it gets.
  • Efficiently boosting customer experience on any leverage point that matters.
  • The most e-commerce companies calculate CLV without previous segmentation of their customer base. In this way they just get the general numbers, missing out on precision. For a more accurate analysis, it’s best when you segment your customer base first.

    Calculating your CLV is just the beginning

    Once you are on top of the segmentation and calculating your customer value, you can take a step further. Start thinking about the leverage points and what you can do to improve your performance. Customer lifetime value is a sensitive measure that is based on many different aspects of your business activity. You can start with some subtle changes that can have a significant impact on the overall score.

    How to improve your Customer Lifetime Value

    According to Econsultancy’s research, there is a lot of tricks and tweaks you can apply to increase your bottom line. The most impactful tactic improving your CLV is your customer service.

    increase CLV in future

    As you see on the screen above, your customer service has the most significant impact on CLV. It’s a no-brainer. At LiveChat, we know best that a better and faster customer experience, the better satisfaction of your prospects.

    That’s a simple fact, and everybody agrees that the customer experience is key to success in e-commerce.

    The winning customer service formula involves taking care of all interactions. Including both pre-sale and post-sale communication with prospects. Buyers aren’t patient or tolerant of being ignored.There is no place for neglect in your business – especially in this regard. You just can’t afford poor quality customer service.

    Top-notch customer service actively boosts customer retention. Such approach lays a solid foundation for better customer lifetime value.

    Do you have a contact form on your site? And do you have a LiveChat on your website up and running?

    Make sure you have these two elements implemented visibly and adequately on your website. Otherwise, this will affect your quality indicators negatively. Prioritize it and care to foster relationships with your customers. Especially with the most valuable and profitable segments and you will see that client satisfaction payoffs in the long run.

    Econsultancy research also indicates that not only customer service is vital to improve your CLV. In fact, all the interactions that you establish with your customers, are of great significance.

    Each interaction is a great opportunity to create the excellent experience, trust, and loyalty. Don’t forget about this when you put your hands on your automation tools.

    No matter if it’s a sales offer, newsletter, or drip campaign, all these touch points should be personalized to use their fullest potential.

    Ensure you create human relationships and emails that look as if they were written manually and directed just one person. Customers want to feel special and see that you care.

    This is why your tone should be just right and reflect the language of your users.

    Back to you

    Okay, it looks like we are here. I hope now you understand what customer lifetime value exactly is. Why is it essential for your e-commerce business, how to calculate CLV at your organization and how you can make the impact and improve it.

    Have any questions? Feel free leave your comment below.

    Happy marketing!

    Graphics sources: Smile.io, Kissmetrics

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