Calculating Customer Lifetime Value | Grow Customer Buy-In and Retention
In marketing and business, we understand the importance of keeping customers happy and fostering long-term relationships. However, in order to effectively build these relationships, we need to understand the value a customer represents throughout their entire engagement with our business. This is where Customer Lifetime Value (CLTV) comes into play. In this article, we’ll dive into the steps involved in calculating CLTV and explore how it can optimize the value derived from each customer interaction.
Step 1: Calculate Average Purchase Value (APV)
To start, you will need to determine the average purchase value. This can be done by dividing the total revenue generated from all purchases by the number of purchases made. To make things simple, let’s assume a customer makes an average purchase of $50.
Step 2: Calculate Purchase Frequency (PF)
Next, you’ll need to determine how often a customer makes a purchase. To calculate purchase frequency, divide the total number of purchases by the number of unique customers. For individual products, this can be measured as the retention rate—the percentage of customers who made repeat purchases within a specific timeframe. For our example though, let’s say that we have an average purchase frequency of 3 purchases per customer.
Step 3: Calculate Customer Lifespan (CL)
The customer’s lifespan refers to the average duration of their engagement with your business. To calculate this, divide the sum of the total customer relationship duration by the number of customers. This could be the time between the first and last purchase, or the length of an active subscription. Here, let’s assume the average customer lifespan is 2 years.
Step 4: Calculate Customer Lifetime Value (CLTV)
Now that you have the average purchase value (APV), purchase frequency (PF), and customer lifespan (CL), you can calculate CLTV using this formula:
APV x PF x CL = CLTV
Plugging in the values from above, the CLTV would be:
$50 x 3 x 2 = $300
Expanding CLTV Calculation to Account for Multiple Products:
To extract deeper insights into customer lifetime value, let’s apply our calculations to include multiple products such as Shoes, Shirts, and Hats.
Shoes:
- Average Purchase Value Per Customer Per Product (APV): $120
- Average Purchase Frequency (PF): 0.6 (60%)
- Average Customer Lifespan (CL): 2 years
CLTV for Product A = $120 x 0.6 x 2 = $144
Shirts:
- Average Purchase Value Per Customer Per Product (APV): $50
- Average Purchase Frequency (PF): 0.9 (90%)
- Average Customer Lifespan (CL): 3 years
CLTV for Product B = $50 x 0.9 x 3 = $135
Hats:
- Average Purchase Value Per Customer Per Product (APV): $75
- Average Purchase Frequency (PF): 0.7 (70%)
- Average Customer Lifespan (CL): 6 years
CLTV for Product C = $75 x 0.7 x 6 = $315
By calculating CLTV for different products, we can gain valuable insights into which customers contribute the most lifetime value and which products retain long-term customers. For instance, customers purchasing hats and shirts would have a combined CLTV of $450 ($315 + $135), allowing you to assign a monetary value to the projected duration of the relationship.
BONUS: Leverage CLTV To Increase Sales
Knowing CLTV is perfect to gauge the customer value over your entire relationship, but it can also help in other ways. If you understand which customers buy certain products, this can illuminate the trends in your customer base. For example, if a customer primarily purchases shirts, but you realize that customers who buy hats spend more over a longer period, it may be worthwhile to offer a bundled package to include a hat. This strategy can increase the average sale amount and potentially extend the customer’s retention, thereby enhancing Customer Lifetime Value.
Calculating Customer Lifetime Value enables you to quantify and optimize the value derived from each customer relationship. By employing this metric, businesses can identify high-value customers, enhance product offerings, and foster long-term customer loyalty. Utilize CLTV to unlock its full potential and make data-driven decisions that drive business growth and success.
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