Calculating Customer Lifetime Value
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Everyone in business values customers highly. But far fewer can put a dollar figure on just how much a single customer is worth over time.

Those business who don’t know their customer lifetime value (CLV) are missing out on a crucial piece of information that can help them set marketing budgets, prioritize customer segments, and understand how much to spend to acquire and retain their clientele.

“Knowing your CLV is the key to effective marketing,” says Tristan Handy, vice president, marketing at RJMetrics, which offers a suite of analytical tools, including CLV calculation, to e-commerce and SaaS providers. “If you know your customer’s lifetime value and what it costs to acquire that customer, you know whether you have a profitable, scalable business or not.” Here are some keys to making CLV work for your business:

  • Calculating CLV. There are a number of ways to calculate customer lifetime value, from back-of-the envelope reckonings to complex analysis based on input from point-of-sale systems, e-commerce platforms, and other information technologies.

“Calculating CLV can get messy fast,” Handy warns. “Companies spend countless hours with SQL queries and spreadsheets to do it, but it doesn’t need to be that complicated. The quick-and-dirty method is to just add up all purchases for a given customer, then take the average across your customer base or whatever segment you’re analyzing.”

The more information you can put into the calculation, of course, the more precise the result. For instance, if you track such data as average order value and repeat purchase rate, you can divide that order value by your purchase rate to create a ballpark estimate. More detailed and accurate versions take into consideration data such as the cost of service, goods sold, customer acquisition, and capital, as well as time between purchases and attrition rate. “When you get to this level, it’s time to start thinking about getting an analytics tool to help out,” Handy notes.

  • Segmenting your customer base. As you delve deeper into customer value, it makes sense to overlay lifetime value atop any marketing segments you may already have. For instance, if you have a healthcare segment, you might discover that independent medical practices have a higher lifetime value than those operated by hospitals. And by correlating CLV to market channels, you can better direct your marketing dollars. In order to fully exploit segmentation, of course, you need to collect more than just order and sales data: You need to track demographic information, acquisition source, and more. Segmenting in this way also lets you target lucrative markets by cloning those high-value customers you already have.
  • Increasing lifetime value. Knowing a particular market segment’s average CLV is just the first step. If you’re smart, you’ll want to increase that number. How? Simply by increasing (or in the case of attrition, decreasing) the elements that go into the CLV calculation, including average order size, frequency of orders, and total duration of relationship. Let’s say you’re an equipment manufacturer, and most of your customers only come to you when they need to make a capital purchase. You could increase lifetime value by adding maintenance into the mix, which generates ongoing incremental revenue and increases the frequency of customer interaction, thus creating further cross- and upsale opportunities.
  • The value of customer-centricity. Focusing on customer lifetime value can create a virtuous cycle in which you take better care of your customers and reap the benefits by retaining them longer and fostering word-of-mouth marketing that no amount of advertising dollars can buy. And speaking of dollars, research continues to reveal that the cost of retaining customers is far less than the cost of acquiring new ones. An often-cited 1990 study by Bain & Company indicates that increasing customer retention rates by just 5 percent increases profits by 25 percent to 95 percent.

If that sounds like an investment worth making, the only way to know for sure is to understand what customers are worth throughout the course of your relationship with them. Is it worth spending months to win that complex enterprise sale? Or are you better off developing your SMB segment? Should you cut prices to retain loyal customers, or is there a more profitable route? By uncovering the lifetime value of your customers, you find answers to these and many other questions while giving your company a competitive edge and a clearer path for growth.

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