How to Calculate Customer Lifetime Value (CLV) & Why It Matters
As an ecommerce expert, it's crucial to understand customer lifetime value (CLV) and how it impacts your business. In this post, we'll cover what CLV is, why it's important, and how to calculate it for your ecommerce business.
What is customer lifetime value (CLV)?
Customer lifetime value (CLV) is the total amount of money your customer will spend on your products or services during their lifetime as your customer. It encompasses all purchases made by a customer over a certain duration of time.
Why is customer lifetime value important?
Customer lifetime value is important because it allows you to track the value and profitability of your customers over time. Here are four reasons why CLV matters:
1. Increasing CLV can increase revenue over time.
By increasing the amount of money a customer spends on your products or services over their lifetime with your business, you'll increase your overall revenue in the long run. When customers see the value in your products or services, they are more likely to continue purchasing from you and refer others to do the same.
2. It can help you identify issues so you can boost customer loyalty and retention.
By tracking CLV, you can identify any issues that may be deterring customers from continuing to purchase from your business. This allows you to address those issues and improve your customer loyalty and retention rate.
3. It helps you target your ideal customers.
By understanding your customers' lifetime value, you can better target the customers who are most valuable to your business. This can help you optimize your marketing and advertising efforts to attract more high-value customers.
4. Increasing CLV can help reduce customer acquisition costs.
Increase customer lifetime value can also help to reduce customer acquisition costs. When you have a high CLV, it means customers are sticking around longer and referring others to your business, reducing your need to spend more on advertising to attract new customers.
Customer Lifetime Value Models
There are two main models for calculating CLV:
Predictive Customer Lifetime Value
The predictive model estimates the potential value of a customer based on their current behavior and actions. It uses predictive analytics to analyze customer data and determine how much they are likely to spend over their lifetime with your business.
Historical Customer Lifetime Value
The historical model looks at past customer behavior to estimate what they will spend in the future. It uses actual customer data to determine how much a customer has spent in the past and how long they typically spend with your business.
Customer Lifetime Value Formula
The formula for calculating CLV is:
CLV = Average Purchase Value x Average Purchase Frequency Rate x Customer Value x Average Customer Lifespan.
How to Calculate Customer LTV
To calculate CLV, you'll need to follow these steps:
1. Calculate the average purchase value.
Divide your total revenue by the number of purchases made by customers during the timeframe you're measuring.
2. Calculate the average purchase frequency rate.
Divide the total number of purchases by the number of unique customers during the timeframe you're measuring.
3. Calculate the average customer's value.
Multiply the average purchase value by the average purchase frequency rate to get the average customer value.
4. Calculate the average customer's lifetime span.
Determine the length of time a customer typically stays with your business in years.
5. Calculate your customer's lifetime value.
Multiply the average customer value by the average customer lifespan to get your customer's lifetime value.
Customer Lifetime Value Metrics
There are four main metrics to consider when calculating CLV:
Average Purchase Value
The average amount a customer spends per transaction.
Average Purchase Frequency Rate
The average number of transactions per customer during a specific timeframe.
Customer Value
The total value of all purchases made by a customer during their lifetime with your business.
Average Customer Lifespan
The average length of time a customer stays with your business.
Customer Lifetime Value Example
Let's say you want to calculate the CLV for a customer who spends $50 per transaction, makes 4 purchases per year, typically stays with your business for 5 years, and has referred 2 customers to your business. Here's how you would calculate their CLV:
1. Calculate the average purchase value.
$50 per transaction
2. Calculate the average purchase frequency rate.
4 purchases per year
3. Calculate the average customer's value.
$50 x 4 purchases = $200
4. Calculate the average customer's lifetime span.
5 years
5. Calculate your customer's lifetime value.
$200 x 5 years = $1,000
Tips to Increase Customer LTV
Here are six tips to help increase your customer lifetime value:
1. Optimize your onboarding process.
Make sure your onboarding process is as smooth and easy as possible to minimize customer drop-off and improve the likelihood that they will become long-term customers.
2. Increase your average order value.
Encourage customers to purchase more by offering bundles and discounts for larger orders.
3. Build long-lasting relationships.
Focus on building a relationship with your customers by providing excellent customer service and personalization.
4. Embrace good advice.
Encourage customers to refer others to your business by offering referral incentives and loyalty programs.
5. Empower easy connections.
Make it easy for customers to contact you and provide feedback so you can address any issues or concerns they may have.
6. Improve your customer service.
Provide excellent customer service to help retain your customers and encourage them to refer others to your business.
The Benefit of Customer Lifetime Value
By calculating and optimizing your customer lifetime value, you can improve your revenue, customer loyalty, and target your ideal customers more effectively. Use these tips to increase your customer lifetime value and grow your ecommerce business.