Master your Customer Lifetime Value (and why you shouldn't rely on it 100%)
Customer Lifetime Value (CLV) is much more than a number - it's an essential asset.
Understanding CLV can transform the way you approach business growth and customer engagement.
But what is CLV and how is it calculated?
Why is it so important, and how can you use it to transform your results?
And what are its limitations?
Let's find out together.
What is Customer Lifetime Value (CLV)?
Customer Lifetime Value represents the total amount a customer is expected to spend with your company over the course of their lifetime.
And it's not just a sophisticated metric: it's one of the pillars of your brand's success.
CLV takes into account a number of factors, including the average lifetime (or cycle) of a customer and the average order value generated by that customer.
Understanding CLV means understanding not only a customer's current value, but also the value they could bring in the future.
It's a bit like having a crystal ball to see the potential of each customer relationship.
This information is invaluable.
Why is it so?
Because it helps you make strategic decisions about marketing spend, sales efforts and loyalty initiatives.
It reveals how much you need to invest to retain your customers and acquire new ones.
If you know that a customer's Lifetime Value is $1,000, you certainly wouldn't want to spend $1,500 to keep them, would you?
It's all about finding the right balance between the customer's value and the investment you're making.
It's also worth noting that in some sectors, the term Lifetime Value (LTV) is used interchangeably with Customer Lifetime Value (CLV), even though they both focus on the same data.
How to calculate Customer Lifetime Value ?
There are two main methods for calculating CLV: by sales and by margin. Each offers its own perspective on customer value.
Let's dive into the specifics of each method.
The Customer Lifetime Value by turnover : the revenue perspective
It's the most commonly used formula for calculating CLV.
Here, you're looking at the revenue a customer brings to your business.
It's a simple approach that lays the foundations for understanding customer value.
To calculate Customer Lifetime Value, multiply the average order value by the average purchase frequency rate, and then multiply the result by the average customer lifespan.
Customer Lifetime Value = (Average Order Value × Average Purchase Frequency Rate) × Average Customer Lifespan
Let's look at each CLV component in detail:
Average Order Value
This is the average amount your customers spend per purchase.
You calculate it by dividing your total revenue over a set period by the total number of purchases during that period.
AOV = Total Revenue / Total Number of Purchases
Purchase Frequency Rate
This measures how often customers buy from you.
It's the ratio of the total number of purchases to the number of unique customers who made those purchases in the same timeframe.
PFR = Total Number of Purchases / Number of Unique Customers
Average Customer Lifespan
This is the average time a customer continues to purchase from your business.
You calculate it by summing up the lifespan of each customer relationship and dividing it by the total number of customers.
ACL = Sum of Customer Lifespans / Number of Customers
The Customer Lifetime Value by margin: the profitability angle
Calculating CLV by margin takes into account not just sales, but the profitability of each customer.
It gives a better understanding of how much real value customers bring.
To do this, simply replace the monetary figure (previously expressed as turnover) with the profit generated per purchase.
Customer Lifetime Value by margin = (CLV by turnover) - (marketing costs × customer lifetime)
Here, by marketing costs, we mean all the costs related to acquiring and retaining a customer.
It includes a wide range of expenses such as advertising costs, promotional materials, social media marketing, email campaigns, SEO, content marketing expenses, and even salaries of marketing staff.
They also encompass expenses involved in customer retention strategies, like loyalty programs, customer service, and engagement activities.
It's essential to capture all these costs accurately to determine the true profitability per customer.
1 Customer Lifetime Value calculation example
Now that we've covered the theory behind calculating Customer Lifetime Value (CLV) through sales, let's see how it works in practice.
We'll use a fictional e-commerce brand, "GreenLeaf Outdoors," to illustrate this, an e-commerce store specializing in eco-friendly outdoor gear.
Let's say they want to calculate their CLV by turnover.
Here’s how they’d do it:
In 2023, GreenLeaf Outdoors had a total revenue of 500,000€ from 10,000 purchases.
→ Average Order Value (AOV) = 500,000€ / 10,000 = 50€ per purchase.
In the same year, these purchases were made by 4,000 unique customers.
→ Purchase Frequency Rate (PFR) = 10,000 / 4,000 = 2.5 purchases per customer per year.
Analysis of customer purchase history shows that customers typically continue purchasing from GreenLeaf Outdoors for an average of 3 years.
→ Average Customer Lifespan (ACL) = 3 years
Putting it all together:
CLV = APV × APFR × ACL = (50€ × 2.5) × 3 = 375€
So, this means, on average, each customer is expected to bring in 375€ over their relationship with the brand.
Understanding this number helps GreenLeaf Outdoors determine how much they can reasonably spend on acquiring and retaining customers.
For instance, if they spend less than 375€ to acquire and keep a customer, they're likely making a profit on that customer.
9 reasons to calculate Customer Lifetime Value?
Calculating Customer Lifetime Value is more than just a few numbers.
It's a strategic tool that has a profound impact on various aspects of your e-commerce business. Let's take a look at the key benefits of understanding and effectively using CLV.
Target customers more precisely
Understanding CLV enables you to identify different customer segments based on their value.
This helps you to implement more targeted marketing strategies.
For example, customers with higher CLV can benefit from more personalized attention or exclusive offers, which can strengthen their loyalty and potentially increase their lifetime value.
Make smarter spending decisions
Knowing your CLV is essential to making informed decisions about allocating marketing resources.
This allows you to adjust the budget to focus more on acquiring high-value customers, guaranteeing a better return on investment.
Pricing for maximum profitability
The results of CLV calculations can guide your pricing strategy.
They provide insight into how much customers are willing to spend over time, helping you to set effective prices that maximize profits without risking customer alienation.
Personalize marketing for greater impact
CLV enables you to determine the most effective marketing tactics for retaining your most valuable customers.
This enables future campaigns to be fine-tuned to improve loyalty, reduce churn and attract new customers similar to those with high CLV.
Develop offers that meet customer needs
CLV data influences product development and service improvement.
Understanding the preferences and needs of high-value customers enables us to adapt offers, thereby increasing customer satisfaction.
More accurate forecasting
CLV is a powerful indicator for predicting future revenues and growth.
It integrates particularly well into business performance analyses, where it is a key KPI for understanding long-term profitability and for planning your long-term strategies more precisely.
Prioritize acquisition and retention with CLV
Comparing CLV with the cost of acquisition (CAC) helps determine priorities: acquiring new customers or retaining existing ones.
For example, if CAC is high, focusing efforts on retaining customers with high CLV can maximize profits without increasing acquisition costs.
This approach ensures balanced budget management and a sustainable customer base.
Keeping customers engaged
A clear understanding of CLV helps develop strategies to increase customer loyalty.
By focusing on satisfying and engaging high-value customers, you reduce churn and guarantee a steady revenue stream.
Efficiently assess marketing impact
CLV is essential for assessing the return on investment of marketing campaigns.
Analyzing the ratio between the cost of acquiring and retaining customers at CLV provides a clear picture of the effectiveness of marketing expenditure over the long term.
How to improve Customer Lifetime Value?
Improving Customer Lifetime Value (CLV) is essential for e-commerce brands aiming for growth and sustainability.
Here are some more detailed strategies for effectively boosting CLV.
Go beyond the basics of customer service
Exceptional customer service isn't just about solving problems.
It's about creating an emotional bond with your customers. Implement a proactive approach by anticipating their needs and responding to them before they become problems.
Personalize interactions and consider offering surprise upgrades or discounts to loyal customers. Use customer feedback to continually improve the experience.
Personalize to deepen relationships
Use data to better understand each customer's preferences and behavior.
Offer birthday discounts, celebrate customer milestones, and offer recommendations based on past purchases.
Personalization should be at the heart of your communication strategy across all channels.
Create a compelling reward system
A well-designed loyalty program delivers tangible value.
Think tiered reward systems, redeemable points, or exclusive benefits.
Keep the program simple and engaging, regularly communicating its benefits to reinforce customers' sense of community.
Improve the online shopping experience
Audit your site regularly to improve the user experience.
Simplify the ordering process, ensure that product images and descriptions are of high quality, and offer fluid navigation.
Integrate tools such as chatbots for instant customer support , and carry out A/B testing to optimize key site elements.
Maintain and elevate quality standards
Make sure you provide products and services that meet high standards.
Set up quality controls and collect feedback to identify areas for improvement.
Highlight the quality and durability of your products in your marketing efforts to reinforce the value perceived by customers.
Display reviews and user-generated content (UGC) to reinforce your credibility
Actively manage customer reviews on your site and platforms.
Share case studies illustrating how customers use your products.
Use user-generated content on social networks to inspire trust and attract leads.
Keep the conversation going
Develop a comprehensive content strategy, including blog posts, newsletters, and social media publications that go beyond product offerings.
Share tips, industry news, or exclusive content to strengthen customers' attachment to the brand and their sense of belonging.
Stay informed and adapt
Use surveys, interviews and feedback tools to gather information directly from customers.
Monitor trends and competitors' actions to stay ahead. Use this data to guide product development, marketing strategies and customer experience improvements.
Prioritize the most profitable customers
Based on CLV, identify the most profitable customer segments and deploy loyalty strategies specifically designed for them.
By prioritizing high-value customers, you can optimize allocated resources and increase profitability.
Intelligently improve purchasing value
Train your team to identify up-sell and cross-sell opportunities in a natural and relevant way.
Use purchase data to suggest products frequently purchased together, ensuring that these recommendations are tailored to individual customer preferences.
7 reasons not to rely on Customer Lifetime Value alone
Calculating Customer Lifetime Value (CLV) is extremely beneficial for e-commerce brands, but it's important to recognize its limitations.
Over-reliance on CLV or LTV can result in a skewed perspective and missed opportunities. Here's why a balanced approach is crucial.
Limits of CLV for short-term sales
An exclusive focus on CLV can lead brands to neglect strategies that generate short-term sales and revenues.
While it's useful to cultivate long-term customer relationships, it's also essential to balance this with tactics that stimulate immediate sales, especially in a competitive e-commerce environment.
Non-adaptability to market changes
CLV calculations are often based on historical data, assuming constant customer behavior over time.
However, market trends, economic changes and competitors' actions can radically alter customer preferences and habits.
Brands need to be agile in responding to these changes, where a static metric might lack responsiveness.
Need to use complementary indicators to CLV: NPS, CSAT and CES
CLV is often insufficient to measure the entire customer experience.
Complementary KPIs to measure customer loyalty are useful.
For example the Net Promoter Score (NPS), which measures the likelihood of customers recommending your brand, the Customer Satisfaction Score (CSAT), which assesses satisfaction during interactions, and the Customer Effort Score (CES), which quantifies customer effort to complete a task, offer additional insights.
Together, these indicators provide a more nuanced view of loyalty and satisfaction, essential for reinforcing loyalty strategy.
Non-value of a diverse customer base
Focusing primarily on high CLV customers can lead to neglect of other customer segments, which may present growth potential.
It's important to recognize the value of a diversified customer base, including new customers or those who spend less but may gain in value over time.
Non-consideration of non-financial indicators
CLV focuses on financial indicators and doesn't always take into account the wider impact of brand perception, social responsibility and community involvement.
These factors can play a crucial role in attracting and retaining new customers, even if this doesn't immediately translate into a high indicator.
Need of accuracy and data collection for small brands
Accurate calculation of CLV requires comprehensive data collection over a long period.
Smaller brands or new companies do not always have access to a sufficient volume of data, which can make it less accurate or even misleading.
Risk of under-investment in customer acquisition
Focusing too much on CLV can lead to under-investment in new customer acquisition .
Acquisition is essential for growth and diversifies the customer portfolio, mitigating the risk of over-reliance on a limited customer base.
