With the correct data and careful analysis, companies can accurately calculate the monetary value each customer brings – a metric referred to as customer lifetime value (CLV or CLTV).
In this article, we cover CLV’s different calculation methods, outlining the benefits of calculating customer lifetime value, the factors you should consider and a simple formula to determine customer value.
What is CLV?
Customer lifetime value (CLV) represents the value of a customer over the entire duration of their relationship with a company. It considers both revenues that have already been generated and those that are expected.
CLV is, therefore, an essential metric for estimating customer profitability and forecasting company growth.
Customer lifetime value: definition and benefits
Customer lifetime value, also known as LTV or Lifetime Value, is the value of an individual customer to the company throughout their “average customer lifespan”. In short, the metric measures a person’s monetary value for the company.
CLV is crucial for sales and marketing efforts to validate whether a customer relationship is profitable. Based on this, companies can calculate how much of their budget to allocate for customer acquisition and retention without incurring losses.
Calculating customer lifetime value enables companies to:
Facilitate budget planning
Focus on profitable and loyal customers
Forecast customer base profitability to provide insight into effective marketing measures and the most profitable channels and products
Upsell and cross-sell.
Calculating CLV provides a deep understanding of the most profitable customers, simplifying decisions for sustainable and long-term customer loyalty.
Factors influencing the calculation of CLV
The calculation of customer lifetime value can vary from one company to another. This variability stems from the factors considered in the calculation, which may not always have the same impact.
For instance, while e-commerce businesses might generate irregular revenues through repeat purchases, a SaaS company expects monthly recurring revenues.
The following factors should be universally considered:
Total revenue generated by a customer
Purchase frequency of a customer
Subscriptions and contracts
Costs for new customer acquisition, marketing strategy, sales and customer relationship management
Discount actions
Example: How to calculate CLV
The customer lifetime value formulas can range from simple to complex, depending on the objective.
Typically, additional metrics are needed for the calculation, which must be determined in several intermediate steps. Here’s a simple example of how to calculate customer lifetime value:
A SaaS company offers its software in different subscription packages. When creating this example lifetime-value-of-customer equation, the following values are important:
Average contribution margin: $200
Repurchase rate: 12 per year (monthly subscription)
Acquisition costs: $150
Number of customers at the endpoint (CE): 350
New customers (CN): 125
Number of existing customers at the start point (CS): 260
Time period: 1 year
For the final formula, you must also calculate the customer retention rate and customer lifetime as follows:
Customer retention rate = ((350-125) / 260) = 0.86 (86%)
Customer lifetime = 1 / (1-0.86) = 7.1 years
Now, you can insert these metrics into the formula for Customer Lifetime Value to get the following value:
CLV = ($200 x 12) x 7.1 - $150 = $16,890
General customer lifetime value calculation formula
From the example above, the following formula for calculating CLV emerges:
Customer lifetime value = (contribution margin x repurchase rate) x customer lifetime – customer acquisition costs
If the numbers and values are overwhelming, you can always count on artificial intelligence to calculate customer lifetime value.
Although understanding CLV’s meaning is significant in marketing and sales, modern Customer Relationship Management (CRM) systems offer automated reports forecasting future and past revenues.
With Pipedrive, for instance, you can create custom sales reports on expected and recurring revenues, allowing for efficient financial resource planning.
Next steps: creating goals for your company
Analyzing CLV is just the beginning. What follows is a catalog of optimization measures. Costs need to be reduced and the relationship with your high-value customers needs to be deepened. To pursue your goal to the end and draw the right conclusions from the CLV calculation, it’s essential to follow these steps:
Goal definition. What do you want to achieve with the CLV analysis? Are you looking to identify the general customer value or calculate the profit margins of specific acquisition channels or products?
Data review and calculation: Check the customer data available to you. Gather all relevant data to determine which calculation is sensible for your company.
Measures and optimization: After calculating the CLV, use this KPI for decision-making and enhancement of customer experience.
If you find, for example, that one acquisition channel yields a better CLV than another, you can directly use this data to optimize your marketing expenditures and actions. Remember to continuously review and recalculate the CLV to keep your strategies effective and up-to-date.
How to increase customer lifetime value
To increase customer lifetime value (CLV), focus on enhancing customer satisfaction and loyalty through personalized experiences and high-quality customer service. Implement targeted marketing campaigns that resonate with your customer base’s core needs and preferences.
Personalized communication and loyalty programs can substantially boost the repurchase rate and customer retention. Using in-depth customer behavior analysis, strategic upselling and cross-selling can generate more immediate revenue, while strengthening long-term customer relationships.
Prioritizing customer feedback and continuously improving your product and service offerings based on this feedback is crucial for maximizing CLV.
Final thoughts: Calculating CLV helps you identify profitable customers
While calculating the CLV might seem daunting, this KPI is incredibly valuable for businesses: it helps separate valuable customers from unprofitable customers, prevents misinvestments and lays the foundation for a sustainable customer journey.
While it’s important to understand the formula for calculating CLV, you can implement it using insight reporting tools and a modern CRM system.
This approach simplifies customer value assessment and aligns marketing and sales strategies more closely with company growth goals, ensuring a robust framework for long-term success.
