It is simpler to persuade a current customer to buy something than it is to gain a fresh buyer. Subsequently, it is critical that you guarantee consumers are content with your product or service so that you have the opportunity to receive a return on the investment made to procure their business.
It is important to ensure that clients do not leave, so that you don’t have to constantly seek out new customers. One of the most effective strategies to reduce this issue is to calculate the customer lifetime value (CLTV). Implementing this strategy will enable your company to secure long-term customers of great benefit, leading to more income in the future.
The metric analyzes the amount of money a customer brings in and then contrasts that amount with how long the business expects them to stay a customer.
As a customer continues purchasing from the same company for a more extended period, the more valuable they become to that company over the course of their entire tenure.
This measurement is something that customer assistance and success groups can impact positively during the customer’s experience. Customer service representatives and client success directors are incredibly important for resolving issues and making suggestions that will boost customer devotion and reduce the number of people leaving their service.
It can also be used to make business decisions. You can take advantage of customer lifetime value to recognize which customer groups offer the greatest value to the organization and focus on them accordingly.
Why is Customer Lifetime Value Important?
Here are some reasons why understanding your CLV is essential:
1. Increasing CLV can increase revenue over time.
A company earns more revenue if the lifespan of a customer is longer or if the customer provides greater worth during that period. Therefore, tracking and improving CLV results in more revenue.
CLV determines which customers bring in the largest amount of money for the company. This permits you to fulfill the requirements of your current customers with items/services they prefer, which in turn will make them content and more likely to spend more money with your business.
It is seen as highly necessary by 55% of businesses that are progressing to make an investment in client service programs, based on a report from HubSpot.
When companies are not seeing any growth or are in a period of decrease in terms of income, only 29% think that investment is “very important.” Businesses that have embraced a focus on ensuring customer success, however, are experiencing greater revenues due to heightened customer contentment.
2. It can help you identify issues so you can boost customer loyalty and retention.
It is beneficial to analyze CLV as a top goal when managing a business in order to detect any potential red flags and establish course of actions to manage them.
If you discover the Customer Lifetime Value to be continually low, you should try to optimize your customer service tactics or loyalty system to match the preferences of your consumers more appropriately.
3. It helps you target your ideal customers.
You can figure out how much a customer spends with your business over a certain period by analyzing their lifetime value. The amount may vary, ranging from fifty to five thousand dollars. Having that understanding, you can create a strategy for obtaining customers that focuses on people who will most likely spend the most at your company.
4. Increasing CLV can help reduce customer acquisition costs.
Acquiring new customers can be costly. It has been highlighted in a report from The European Business Review that the cost of acquisition is generally five times greater than that of retaining customers.
A different study from Bain & Company noted that a 5% growth in retention rate could cause an increase in revenue ranging from 25% to 95%.
This data demonstrates the significance of recognizing and developing relationships with the most profitable customers that work with your organization. By taking this action, you’ll be able to have greater profit margins, lengthened customer lifetime values, and minimized customer acquisition expenses.
Now that we comprehend the significance of customer lifetime value, let’s look more closely at how to calculate lifetime value.
How to Calculate Customer LTV
To find Customer Lifetime Value (CLTV), you must take the average expenditure an individual customer makes combined with the number of purchases they make on average and then multiply the two amounts together. Work out the average time a customer sticks around, then multiply that number by the value of each customer to figure out the customer lifetime value.
We shall investigate both elements of this equation (and understand how to find them) below.
Customer Lifetime Value is equal to the value of a customer multiplied by their average time period as a customer.
Customer Value is equal to the average amount of money spent on each purchase multiplied by the total amount of purchases made.
Customer Lifetime Value Model
Two approaches that firms can utilize to calculate a customer’s lifetime value are present. Selecting between the two possibilities can deliver different results, depending on if a company is eyeing existing data or attempting to gauge future customer habits in light of the current environment.
Predictive Customer Lifetime Value
A CLV model that predicts behavior can be used to anticipate how existing and new consumers will purchase goods, through regression analysis or employing machine learning.
The predictive model for customer lifetime value assists in recognizing the customers who are the most important, the product or service that generates the most earnings, and ways to raise customer retention.
Historical Customer Lifetime Value
The historical model uses existing information from the past to forecast the worth of a customer without taking into account whether the client will stay with the company or not. The value of customers can be calculated using the average amount of their orders according to the historical model. This model will prove beneficial if the majority of your customers have dealings with your company for a certain length of time.
Nevertheless, due to the fact that the majority of customers do not have identical experiences, this system has some negatives. Customers that have been considered valuable based on past information may become dormant, causing your data to be inaccurate. Conversely, those customers who have not recently purchased anything from you could start to buy from you again, but you might not recognize this because you have identified them as “inactive”.
Customer lifetime value formula
It is time to assess the worth of each section you have classified with RFM to establish which of your customers are the most proficient.
To figure out the customer lifetime value of each of your segments, you will need to find three important pieces of information over a certain period of time: the average order cost, how often purchases are placed, and the customer worth.
Average order value
Average order value represe
Purchase frequency
The average number of orders per customer is what is referred to as purchase frequency. In the same length of time as to calculate the normal order amount, break down the total number of orders by the number of distinct purchasers. The result will be your purchase frequency.
Merchants who use Shopify can also access this information in the Reports section, located under Sales by Customer.
Purchase Frequency = Total Orders / Total Customers
Customer value
The amount of money that each customer contributes to a business over a period of time is referred to as customer value. To work out how much your customers are worth, simply multiply the average cost per order by how often they buy.
Customer Value = Average Order Value x Purchase Frequency
The typical sum a customer spends whenever they make a purchase. To calculate this amount, divide your total income by the total amount of orders placed.
If you own a Shopify store, the reports page in your Admin can tell you the amount of sales received each month. To calculate your sales for the past year, divide the total amount of sales by the total number of orders.
Make sure you click ‘Define’ when looking at your total sales, and only select Subtotal for the most accurate results.
Average Order Value = Total Sales / Order Count
How to calculate the lifetime value of a customer
Once you have figured out the worth of each customer group, computing their CLV is a piece of cake. All you need to do is multiply the customer value with the average customer duration.
The amount of time that it takes for a customer to stop shopping with you, typically ending the relationship between you and the customer, is referred to as the average customer lifespan.
Understanding the distinction between serving customers on a contractual or non-contractual basis is critical in evaluating customer loyalty.
Once a purchase from a virtual store has been completed, there is no contractual agreement and the exchange is done. It can be difficult to determine when an individual who habitually purchases your products or services will cease buying them, and never make another purchase from your business.
Nevertheless, some types of e-commerce take the form of agreements, such as those stemming from subscription-box companies. When customers decide to terminate their contract or subscription, it is then clear when the client has become inactive due to the structure of the contractual business. It is simpler to estimate the typical duration of a customer’s dealings when working with a contractual business.
If your shop has just opened or has been in existence only for a short period, you may not have a sufficient amount of information to ascertain the typical time a customer stays a patron. No need to be concerned – there is an efficient way to proceed so that you can obtain information that can be utilized from your calculations.
For shops that are more recently established, approximately three years is a reasonable guess for their duration. This will give you a sound basis to anticipate how customers will behave in the near future, as well as supplying extra motivation to maintain them.
How to increase your customer lifetime value
Even though you may have found some promising outcomes from your calculations, there’s always scope to do better! These are some strategies for ensuring you make the most out of each client connection by discovering new chances to enhance their worth.
1. Start a loyalty program
A vast majority of businesses have an initiative to reward customer loyalty. They are a great way to increase income and keep customers coming back. The majority of clients declare that they would stay faithful to a company that provided loyalty schemes, and two thirds of them advise that gaining remunerations actually affects their purchasing habits.
Show your appreciation for the customers who keep coming back to your business by establishing a loyalty program with gifts and rewards for those that make repeat purchases. You can offer different perks to encourage upsells and cross-sells like:
- Points
- Gift cards
- Discounts
- Cash back
- Free swag
2. Invest in customer experience
The pandemic necessitated an alteration to the way brands, spanning all industries, interacted with their customers. Almost right away, online stores began to concentrate on meeting their customers’ demands by making it possible to shop online, while also creating an emotionally satisfying experience.
The XM Institute has recently indicated that if a customer finds the experience they get to be “very good”, there is a 95% chance they will recommend the company.
Some easy ways you can improve customer experience include:
- Being open to customer feedback and using that information to improve the experience
- Removing high-effort tasks like slow customer support and payments processing
Customer experience requires consistent nurturing and care. Using the proper strategies, you can have a positive effect on your customer’s experience and generate more revenue and greater customer lifetime value.
3. Offer easy returns
It is impossible to circumnavigate returns and refunds when running an online business. Approximately $428 billion in goods were sent back by shoppers in 2020, accounting for 10% of all retail transactions. Evidence indicates that one fifth of items purchased online are returned, so come to a compromise.
4. Upsell and cross sell
Encouraging customers to purchase an advanced or more expensive version of something they have already bought or other goods is called upselling. The products tend to cost more, with the intention of generating more revenue. This is an approach to marketing which is focused on trying to get repeat business from customers who have already made a purchase, rather than trying to acquire new customers.
Upsells work to increase CLV for two reasons:
- The probability of selling to an existing customer is 60% to 70%, compared to a 5% to 20% chance of selling to a new one.
- It increases average order value, which contributes to higher customer lifetime value.
Cross-selling is often confused with upselling. The distinction is that when cross-selling, one suggests a product that works in conjunction with the primary item, whereas with upselling, a better quality version is promoted. Cross-selling could be compared to a waiter suggesting an additional order such as “Would you like fries with that?” Upselling, on the other hand, could be likened to asking if you’d like to upgrade an order, for example “Would you like Hendrick’s instead of well gin?”
The Benefit of Customer Lifetime Value
Customer lifetime value is an incredibly useful metric. It informs you of which customers are most likely to invest the most in your business and will stay committed to you for the longest period. Take advantage of the formulas and the model given above and start determining the Customer Lifetime Value for your company straight away.
The historical model assesses the worth of a customer on the basis of past data, regardless of whether the customer is likely to remain with the company or not. Using the history of past orders, one is able to estimate the monetary value of their customers. This model will be especially beneficial if a majority of your customers make contact with your business during a limited amount of time.
Nevertheless, because the majority of clients have different routes, this framework has some flaws. Customers who have been deemed to be of value based on past models may turn out to be inactive and thus alter the results of the data. Unlike active customers, people who have not been purchasing items recently may start to shop with you again, but you may miss the opportunity if they have been labeled as inactive.
Get informed about the various measurements required for computing customer lifetime value and the significance of them.
