A key component of any good business strategy is understanding which customers offer the best long-term value and learning how to leverage that into growth. You need high-value customers that continually bring in revenue time and time again. Figuring out who these customers are can be challenging, though.
That’s where customer lifetime value (CLV) comes into play. This simple metric helps you predict the total value a customer provides over their business lifetime.
Knowing how and when to calculate it will help you better prioritize and devote resources to maintain these customers. We’ll walk you through exactly what CLV is, how to calculate it, and how to increase it below.
What is Customer Lifetime Value (CLV)?
Customer lifetime value is the total estimated revenue a customer will bring in over the course of their lifetime as a customer. It’s a behavioral metric that can be used to determine the likelihood of continued customer loyalty. In other words, how valuable a customer might be to your business over time.
For example, if you sell wedding rings and only expect a customer to buy one wedding ring in their lifetime, then the cost of that ring will be their CLV. However, if you sell shoes that need replacing once or twice a year, a customer’s CLV will be the total revenue they bring throughout their lifespan shopping with you.
Even if the average order size of a wedding ring is much larger than a pair of shoes, the CLV will often be higher for smaller purchases that happen frequently over a longer period of time. Understanding that can help you shape your products, services, and marketing towards the high-value customers.
Why Is Customer Lifetime Value Important to Businesses?
CLV is a key metric when looking to grow your business. For one, it helps you understand the value your customers get from your products or services and strengthen those areas of the business, while abandoning areas that don’t improve CLV.
For another, it allows you to determine how to market to higher-value customers that will spend more over the course of a lifetime.
Measuring and understanding your CLV:
- Helps determine accurate customer segmentation in your marketing strategy, as it allows you to focus on high CLV customers
- Allows you to take a honest look at products and services and whether they offer value to customers or should be discontinued
- Increases overall profitability and improves your ability to accurately forecast your financial growth
- Helps you assess and measure customer loyalty, to find ways to improve it over time.
How to Calculate Customer Lifetime Value
There are two main ways of calculating your CLV: historic or predictive modeling. Historic CLV relies on existing data from customers, whereas predictive modeling uses an algorithm to predict expected future outcomes from new or potential customers.
The formula for historic CLV is the sum of all transactions multiplied by the average gross margin.
[Transaction 1 + Transaction 2… + Transaction N] x [average gross margin] = CLV
Transaction N represents the most recent transaction of a particular customer.
Historic CLV is easier to calculate on an individual basis, making it more accurate on the micro level. It takes into consideration the business costs of the transaction so it can give a more precise answer. However, it can be tedious to calculate for each individual customer and doesn’t take into consideration future purchases.
That’s where the predictive model of CLV comes in. This works off averages and can give you an overall CLV for your business, which is better for long term forecasting. The predictive model formula consists of three main components:
- Average purchase value: the estimated revenue of a single purchase
You can calculate this by taking the total revenue of your business over a given period (a year is the easiest to calculate) and dividing it by the number of purchases made during that period.
- Average purchase frequency: how often an average purchase would be made in the given period
To calculate this, divide the number of purchases by the number of unique customers during the selected period.
- Average customer lifespan: the general length of time a customer will usually continue to purchase from you
To get this, you can take the sum of all your customer lifespans and divide it by the total number of unique customers.
Now, to get the average CLV of customers, simply multiple these all together:
[average purchase value] x [average purchase frequency] x [average customer lifespan] = CLV
Let’s look at this formula in action.
You own a local comic book store and want to figure out your average CLV.
First, you determine that your average purchase value is $20 – most customers purchase one comic book per visit. Next, you work out that customers purchase one book a month, so your average purchase frequency in a year is 12. Finally, you calculate that the average customer lifespan is roughly 10 years (say from about age 10 to age 20).
Now you can put the variables together.
$20 x 12 x 10 = $2,400
The CLV of your average customer is $2,400. While this value may not help you determine any extra variables like acquisition or marketing costs, it gives you a general sense of how much value your customers bring. This is especially useful if you have several product lines and want to calculate the CLV for each target customer base.
How to Increase Customer Lifetime Value?
No matter where your CLV is currently, there is always room for improvement and growth. Increasing your CLV will take time and is multifaceted, so you can approach it from several directions to see the best results.
1. Enhance the Customer Experience
Over the customer lifetime, your customer might interact with several different touchpoints of your business – the website, your storefront, email updates, and more. These should all be optimized in a way to make the experience enjoyable for the customer, which entices a customer back and increases their CLV.
Generally, this just means being an easy business to deal with, to encourage people to return time and time again. This might mean ensuring your website is responsive and easy to navigate or that your staff are pleasant and helpful. Smooth, stress-free shopping experiences can help improve customer retention which, in turn, increases CLV.
2. Start a Loyalty Program
Another way to increase CLV over time is to start or improve a loyalty program for your business. With so much competition out there, especially for online stores, having a loyalty program can be a great way to stay engaged with existing customers.
A loyalty program works to encourage frequent and recurrent purchases, while providing some additional value to the customer – points, pre-launch access, exclusive discounts, and more. You want to create rewards that are of real value to the customer, while also providing them reason to remain loyal to your brand.
3. Improve Customer Service and Support
Most customers would agree that having prompt customer service is a key factor in how they perceive a business. This includes everything from fast shipping, prompt support for questions or concerns, and a clear, robust return policy if things aren’t just the way they had hoped.
You can improve your customer support by introducing omnichannel support through the use of automated chat bots, email assistance, and ongoing, personalized communications. You can also introduce a return policy that makes it convenient for customers to return what they don’t like in a hassle-free way.
4. Increase the Average Order Value
One way to help boost your CLV is to increase the average order value of each transaction. This can be done through upselling and cross-selling techniques that invite customers to spend more.
This might include showing related products at checkout or offering bundles with a slight discount, if you have an online store. Or it might mean offering small add-ons or suggesting a better offering. It may not seem like much in any one transaction, but over time it really adds up and can increase your profitability.
5. Optimize Your Marketing
A great way to increase CLV is by identifying and targeting the customers that are more likely to spend more across their customer lifespan. Knowing this can help you prioritize your marketing plan to figure out where to spend your budget for the highest ROI.
Generally speaking, retaining existing customers is cheaper than acquiring new ones. By calculating your CLV you can figure out what group of customers provide the biggest value and work to target them with specific and segmented marketing campaigns through email, social media, and content marketing.
The Benefits of Working with Pay.com as Your Payment Service Provider
As mentioned above, one of the best ways to increase CLV is by having a smooth customer experience, and that includes the checkout process. No matter what kind of business you operate, you want your customers to be able to pay quickly and easily. That’s where Pay.com can help.
Pay.com offers a variety of payment methods including digital wallets, ACH transfers, standard credit and debit card payments, and more. Offering your customers different options allows them to choose to pay in the way that they prefer.
If you operate an online store front, you can integrate Pay.com’s fully customizable checkout page directly onto your website, so customers can pay without leaving the page. If you don’t have a webstore, you can also send Pay Links through email or SMS to customers and direct them to personalized checkout pages.
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The Bottom Line
Calculating and understanding your CLV is a great way to build a robust marketing and growth plan for your business. It helps you determine which customers are worth pursuing and which aren’t, by putting a quantifiable number on their purchasing power.
Once you’ve determined your average CLV, you can build a strategy to increase it through enhanced customer experience, loyalty programs, and targeted marketing campaigns. This will help your business flourish and hopefully gain a positive brand reputation.
Pay.com is a great way to enhance customer experience through a smooth and streamlined checkout process. With a fully customized checkout page or personalized Pay Links, you can make it convenient for your customers to pay however they prefer.