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Customer Lifetime Value (CLV)

What is Customer Lifetime Value?

The Customer Lifetime Value (CLV) describes the value the customer has for the firm over a lifetime. This means, the current value of a customer and the potential future of a customer are determined. As it is not possible to fully predict the future, it is mostly an expected value.

It is used to calculate the cost of acquiring a customer (CAC) and to benchmark it against the expected benefit of that customer’s business during his lifetime.

Hence, it is the completely total contribution margin realized by a customer throughout his or her entire lifetime. In other words, it describes the amount of money a customer is going to spend at a specific company.

The CLV is an important metric to consider in marketing attribution as it helps businesses understand which channels are incremental in driving customers with a high CLV.

In the context of attribution, it makes it clear that it is a well-suited context for multi-touch attribution. It is very convenient to use with multi-touch attribution, because you can compare which channels are the most preferred and have the best performance. So this is something you would much rather apply to this than to a single-touch attribution model like last click attribution.

CLV is used to maintain a long-term customer relationship, as existing customers are easier to maintain than acquiring new customers.

How is the Customer Lifetime Value calculated?

Calculating CLV is done with a simple formula. However, you need to determine which type of CLV you want to calculate. There are 2 types of CLV. There is:

  • A company-wide CLV (i.e., the average CLV across all the customers of your company), or

  • an individual-level CLV of specific customers.

To be able to calculate company-wide CLV, you will need:

  1. Average Purchase Value. You can calculate this by dividing your total revenue in a period by the number of purchases throughout the same period of time.

  2. Average Purchase Frequency. This metric is calculated by dividing the number of purchases by the number of unique customers.

  3. Average Customer Lifespan. This is determined by dividing the sum of customer lifespans by the number of total customers.

  4. Customer Value. This is calculated by multiplying the Average Purchase Value by the Average Purchase Frequency rate.

To calculate customer lifetime value, one needs to multiply the Customer Value by the Average Customer Lifespan.

Hence: Customer Value * Average Customer Lifespan = CLV

When calculating this CLV, you will be able to obtain a monetary figure depending on your currency. This specific figure indicates how much you can expect the average customer to spend.

However, you can also calculate the CLV on an individual level. This is mostly used in customer service or organizations where it is feasible, e.g. telecommunications.

For these companies, it is good to know how far you need to go to prevent a customer from churning. When a customer complains or calls, the agent can quickly make a decision on how to proceed.

This shows that, according to the CLV model, if the customer is above a certain value, customer support decisions are likely to be made in favor of them.

The formula for the individual CLV is easier compared the company-wide CLV. You simply multiply the amount a customer spends per year by the number of years you expect them to stay with your firm. From that, you deduct the customer acquisition cost.

Customer Lifetime Value (individual).

Customer revenue * Total duration - Acquisition and Retention Cost.

Traditionally, the calculation was based on four different metrics:

  1. Cost to Acquire the Customer (CAC). The company or its managers first need to find out how much money it costs to acquire the customer.

  2. Annual Profit. Profits depend both on the revenue the customer brings to the firm and the costs it takes to serve the customer. Some customers are more profitable as they buy non-discounted products, or purchase more and expensive products. It is determined by subtracting the costs minus the revenue of the customer.

  3. Length of the Customer Lifetime. This describes their brand loyalty. It is either done with a retention rate r (calculated as 1-c) or a churn rate c (calculated as 1-r). The number of years is calculated as 1/c

  4. Discount rate (i). Money today is more valuable than in the future, so it is discounted.

Thus, the traditional formula is CLV = m/(1+i-r)

Why should you determine the Customer Lifetime Value?

There are several reasons why you should consider the CLV in your marketing strategies. But what are the reasons?

1. The Company’s revenue is affected.

Identifying the CLV means identifying the customers who bring the most value. This means, this portion of your customer base can be served with your best offers to keep them happy.

This is important because more and more firms moved towards a customer-centric approach focusing on the customer. Hence, they strive to improve customer satisfaction.

If you do not measure these numbers, you simply will not be able to improve them. Once you measure them, you can opt to employ strategies surrounding pricing and sales to improve on them.

2. Targeting

Knowing the CLV also means knowing a monetary value of each customer. This means you are able to evaluate what customers are relevant to use.

3. Customer Retention

It is important to maintain the customers with a high CLV - so you can target them with offers to improve customer loyalty and retention. This enables you to improve customer retention. And who knows, maybe these customers might also refer you.

Besides that, spending to acquire new customers is typically more expensive than retaining your loyal customers and results in less revenue down the line. So the focus on a good customer experience and retaining your customers for a long time is more profitable than acquiring lots and lots of new customers.

4. To Acquire or Not to Acquire

Calculating CLV gives you the insights into all your customers - insights into average order revenue, the profitability and acquisition costs. Hence, it helps you to make a decision quite easily. If the CLV exceeds acquisition cost, you may want to acquire to the customer, if not, don’t.

The CLV is a tool that perfectly allows you to maximize profitability whilst continuously attracting the right types of customers and encouraging them to shop repeatedly. The CLV can be used to strategically come up with strategies that encourage this behavior and lead loyal customers to more purchases.

5. Do better Marketing based on Multi-Touch Attribution

CLV and multi-touch Attribution together make you not only understand which channels perform the best and are incremental, but also which high-profile customers (i.e high CLV) use them - hence, using multi-touch attribution models is inherently a much more effective option than single-touch models, such as last click attribution.

Customer lifetime is important to consider

Customer lifetime value is a crucial metric to consider. It tells you which customers are your most loyal customers and who spends the most on your business. This helps to offer a product or service that leads to an increased CLV, and thus more income

How can Marketing Attribution and Customer Lifetime Value be aligned?

When having a clear view of the (expected) customer lifetime value of a customer, this can also be used in marketing tactics. You want to look at the channels that are generating new customers with a high CLTV. But, you don’t want to do this based on last-click, but on multi-touch attribution.

This shows that Customer Lifetime Value and marketing attribution has a certain synergy, one that allows to reveal the best strategy to target an audience and optimize marketing channels.

A short example of the CLV concept

Almost anything can be used as an example for CLV. For instance, a small web shop of sustainable coffee beans has an average sale of 5 euros. Typically, the customer shows up there 1 time a week, on 40 weeks on an average of 8 years.

In this example the CLV = 5€ x 1 x 40 x 8 = 1.600,-€

Generally, this concept is easy to implement and to illustrate with other examples. However, it has certain limitations:

  • It can be hard to measure at times, especially for small businesses who do not operate with high quality Customer Relationship Management (CRM) software, and

  • In some cases, results might be misleading if they are viewed from a company-wide perspective, which implies that breaking the data down by location or customer segments might deliver new insights into the data obtained.

If you manage to implement CLV in an efficient way, you can be sure that your targeting will be highly effective and you will be able to reach the right customers who are the most profitable.

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