New customers are coming in every week, so you’re certain your business is growing. But a quick look at your financials shows your bottom line hasn’t budged. You have more customers than before, so what’s going on?
Analyzing your Customer Lifetime Value (CLTV or LTV) can bridge the gap between your perceived performance and your actual bottom line.
Of course, that’s easier said than done.
Often talked about but still overlooked, Customer Lifetime Value measures how much your customers are genuinely worth. Unfortunately, determining CLTV isn’t as straightforward as it is important. To complicate matters, how to calculate LTV will vary from business to business.
It’s no surprise, then, that only an estimated 42% of companies calculate this critical metric correctly.
Let’s say you’re one of them, and you have this important information in front of you. What do you do with it?
What Is Customer Lifetime Value?
Customer Lifetime Value is the amount a customer is expected to spend with your business during the “lifetime” of their relationship with you. Also known as CLTV, CLV, or Lifetime Value (LTV), it can be used to highlight the importance of value creation for your customers. Ultimately, this focus allows for the strategic planning necessary for the long-term, sustainable growth of your business.
The power of Customer Lifetime Value lies in the incorporation of key metrics that directly impact future revenue. CLTV incorporates conversion percentages, customer rates, customer retention, and much more.
In its simplest form, Customer Lifetime Value tells you how much value your customers have brought throughout the entirety of their relationship with your business. In fact, revenue is just the sum of CLTV for every single one of your customers.
Why Does Customer Lifetime Value Matter?
The connection between CLTV and revenue is clear, but the benefit goes far beyond that. Customer Lifetime Value is a valuable health indicator for your company. This analysis reveals information about your business that you wouldn’t otherwise uncover.
Some of the many benefits include:
Loyalty & Retention
In business, we know loyalty matters. The lifetime value of your customers is a lagging indicator of overall customer satisfaction. And satisfied customers are often more loyal (however, the exact relationship between satisfaction and loyalty varies by industry).
Plus, loyal customers are great promoters — 92% of consumers trust recommendations from someone they know over general marketing. Existing customers are 50% more likely to try your new products and spend 31% more than new customers. Not only that, but the possibility of converting an existing customer is 60-70%, compared to 5-20% for new customers.
Retargeting & Segmentation
What if you find you’re targeting the wrong customer segments? Understanding your Customer Lifetime Value can help you evaluate your customer segments and course-correct so you focus your marketing efforts on the right audiences.
Completing a Customer Lifetime Value analysis allows you to understand which customers bring the most value to your business. Once you know who your most valuable customers are, you can identify and use commonalities between these customers to create data-driven retargeting campaigns and improve segmentation.
Strategy & Decision-Making
CLTV can help you understand the return on your marketing investments and create more profitable long-term and short-term objectives.
Customer Lifetime Value can be used in conjunction with other marketing metrics to create demand forecasts for long-term project planning, future investments, and product road mapping.
The Lifetime Value of a Customer: What You Need to Know
If those benefits weren’t enough to convince you that you need to know your Customer Lifetime Value, let’s look at some statistics:
- It costs 5 to 25 times more to acquire a new customer than to retain an existing one.
- A 5% increase in retention can result in a 25% increase in profit.
- A 2% increase in customer retention can have the same impact as reducing costs by 10%.
- On average, existing customers spend 67% more than new customers.
That’s right, knowing your Customer Lifetime Value can help you maximize your profits.
With those stats in hand, it’s time for CLTV formulas!
How To Calculate Customer Lifetime Value
The easiest way to calculate customer lifetime value is to multiply the value of a sale by the average customer lifetime and subtract acquisition costs. However, approaches for how to calculate LTV can differ depending on your business model.
How To Use Historical Modeling to Calculate Customer LTV
One way to calculate the value of a customer is by using past data. While it’s a simple equation to find the average order value of your customers, this type of modeling has limited use when applied to your entire customer dataset because it doesn’t account for the “lifetime” of individual customers.
However, historical modeling can be valuable for finding the average CLTV for a customer segment based on industry, marketing channel, or a specific product line.
Make sure you have the following data for our customer lifetime value formula:
- Value of a Sale: Profits generated after a sale
- Average Customer Lifespan: How long a customer has been doing business with you
- Acquisition Cost: The total spend to acquire your customer
Here’s the Customer Lifetime Value formula:
To perform a CLTV calculation, you first need to determine your customer value. You can do this by finding the average purchase value and multiplying that number by the average number of purchases. Multiply that number by your customer lifespan, then subtract the average acquisition cost to determine a customer lifetime value.
Let’s look at common marketing metrics used to calculate CLTV, including what they mean, how to calculate them, and how they relate to CLTV.
How To Use Predictive Modeling to Calculate CLTV
Predictive modeling forecasts the future buying behavior of new and current customers.
There are two main types of predictive models.
The first method involves applying a probability distribution to the dataset (different probability distributions will be relevant for different business models). The second approach is to do a regression analysis to create a line of best fit. You can accomplish this with a multivariable linear equation or a logarithmic trendline applied to your historical dataset (try this in Excel).
Which Metrics Impact Customer Lifetime Value?
Average Customer Lifespan
Average Customer Lifespan (ACL) is how long each of your customers has been doing business with you, on average. To understand ACL, you need to know your Churn Rate.
Churn rate refers to the percentage of customers that stop working with you. If your rate of growth is faster than your churn rate, your customer base is expanding.
You can calculate your churn rate by subtracting the number of customers at the beginning of a period from the total number of customers at the end of the period. This difference is divided by the total number of customers at the start of the period. Multiply this number by 100 if you want a percentage.
For example, if you had 150 customers at the beginning of the month and 9 chose to end their contract without renewal at the end of the month, your churn rate is .06 or 6%. The period you select to calculate your churn rate should relate to your typical customer contractual period.
There is a critical difference in how ACL is calculated between contractual businesses (like Victorious, which offers contractual SEO services) and non-contractual businesses (like an e-commerce retail store). While churn rate can be applied to both business models, in a contractual business model, the method to calculate churn rate is more intuitive.
In contrast, a product-based business must clearly define a churn event. For example, if you’re an online retailer, you may notice customers are likely to make an additional purchase within a certain period of time. You might define a churn event as a customer who hasn’t made a subsequent purchase within this timeframe.
Can’t calculate your Churn Rate? You can use historical data.
Value of a Sale
Regardless of your business model (whether you offer products or services), the Value of a Sale is simply the profits generated after a sale. Similar to Customer Lifetime Value, there is a key difference in how to calculate the Value of a Sale depending on whether the business is contractual or product-based.
If you have a contractual or subscription-based business, you’ll want to take into account the average length customer contract.
In contrast, if you have a product-focused business, you’ll want to consider repeat purchases and the frequency you expect customers to purchase from you.
Acquisition cost refers to the total amount spent to acquire a prospective customer. The formula will differ depending on what costs are accounted for. It’s common practice to take the total marketing spend and divide it by the number of customers. This gives you the average customer acquisition cost.
Another Way To Calculate Customer Lifetime Value
While Customer Lifetime Value can be calculated for all businesses using the Value of a Sale, Customer Lifetime, and Acquisition Costs formulas, some businesses may prefer using the Customer Value and Average Customer Lifespan (particularly product-focused businesses that prefer to leverage historical data) metrics.
Average Purchase Value
Average Purchase Value (APV) is the total revenue of your business divided by the number of orders. This calculation is most applicable to product-focused businesses.
Average Purchase Frequency Rate
The Average Purchase Frequency Rate (APFR) is the average number of times a given customer will purchase from you within a set time period. This calculation is also most relevant for product-focused businesses.
Not to be confused with Customer Lifetime Value, Customer Value focuses on value provided during a set time period. Customer Value (CV) is calculated Using the APV and APFR:
How To Use CLTV
Now that know how to measure Customer Lifetime Value, let’s talk about some of the things you can do with it.
Dive Into Your Customer Data
Not only can you use Customer Lifetime Value to segment and retarget your most worthwhile customers, but you can also find which customers cost more than they’re worth.
While it’s crucial to understand which customers bring the most value, understanding which relationships aren’t benefiting you is also important.
Understand Your Business
Customer Lifetime Value can also provide insight into your marketing activities by highlighting which channels lead to higher CLTV. Given the clear connection between CLTV and revenue, these channels likely have the greatest ROI.
This same approach can be applied to your products and services. Understanding which products and services result in the greatest CLTV can lead to better decision-making and a better long-term strategy.
Focus on Maximizing Value Instead of Minimizing Spend
When looking to increase profits, it’s tempting to prioritize the reduction of spending over initiatives that are an effective use of budget.
Reducing spending is not the only (or in some cases the best) path to increasing value.
More often than not, the strategy that leads to the greatest long-term success for your business is the approach that creates the most value. This won’t always be the least expensive strategy, although sometimes it will be.
Customer Lifetime Value shifts the focus from short-term strategies focused entirely on minimizing spend and instead focuses on adding long-term value to revenue generation.
SEO & Customer Lifetime Value
Given the impact Customer Lifetime Value has on your bottom line, customer loyalty and retention are critical for your business.
According to the Content Marketing Institute, organic search improves customer retention and loyalty:
Organic search keeps sending your customers and brand advocates back to your site. It keeps them consuming your content.”
The impact might not be obvious at first glance, but SEO is one of your key levers for influencing customer loyalty. Not sure how much you should be investing in SEO to impact CLTV? Download our free ebook to learn how to budget for SEO.
How To Budget for SEO
Unleash your true search potential by planning for SEO in your marketing budget. Download our free guide to learn how to budget for SEO.
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At our SEO agency, we have a full suite of SEO services and have demonstrated success in almost any business you can think of (check out some of our SEO case studies). Reach out for a free SEO consultation.