New customers are coming in every week, so you’re certain that business is growing. But a quick look at your financials shows your bottom line hasn’t budged a bit. You know you have more customers than before, so this doesn’t make sense.
What’s going on?
Analyzing your Customer Lifetime Value (CLTV) can bridge the gap in understanding between your perceived performance and the actual bottom line.
Easier said than done.
Often talked about but still overlooked, Customer Lifetime Value measures how much your customers are genuinely worth. Unfortunately, determining CLTV is not as straightforward as it is important. To add to the complexity, how to calculate customer LTV will vary from business to business.
Regardless of importance, it’s estimated only 42% of companies can calculate this critical metric correctly.
And, once you do calculate your Customer Lifetime Value correctly, what do you do with it?
Let’s start from the beginning.
What is Customer Lifetime Value?
Customer Lifetime Value (also known as CLTV or CLV) or Lifetime Value (LTV) is often seen as the “true north” of marketing metrics. CLTV is an all-encompassing figure that can be used to highlight the importance of value creation for your customers. Ultimately, this focus allows for the strategic planning necessary for long-term and sustained growth of your business.
The power of Customer Lifetime Value lies in the incorporation of key metrics that directly impact future revenue. CLTV incorporates everything from conversion percentages, customer rates, 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 would not have otherwise uncovered.
These are just some of the many benefits:
Loyalty and Retention
The lifetime value of your customers is a lagging indicator of overall customer satisfaction. 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.
In business, we know that loyalty matters.
Existing customers are 50% more likely to try your new products and spend 31% more compared to new customers.
Retargeting and Segmentation
Pareto’s Principle says 80% of your revenue comes from only 20% of your customers.
Using CLTV, you can identify customer segments where value is mutually shared and maximized.
Perhaps you find that your business is targeting the wrong customer segments. A poor acquisition strategy results in low qualified conversions.
Understanding your Customer Lifetime Value can help.
Completing a Customer Lifetime Value analysis allows you to understand which customer brings the most value to your business. Once you know who your most valuable customers are, commonalities between these customers can be used to create data-driven segmentation.
This highlights why CLTV can be one of the more powerful tools for targeting the right customers.
Strategy and Decision-Making
CLTV can help you understand the return on your marketing investments and create more profitable long-term and short-term objectives.
When combined with other marketing metrics, Customer Lifetime Value can be used to create demand forecasts for long term planning for projects, 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:
Customer loyalty and retention are cheaper.
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%.
Existing customers spend more.
On average, existing customers spend 67% more than new customers.
How to Calculate Customer Lifetime Value
Depending on your business model, there can be many approaches to how to calculate customer LTV (CLTV).
The easiest way to calculate customer lifetime value is to multiply the value of a sale by the customer lifetime and subtract acquisition costs.
Let’s break that down.
How to Use Historical Modeling to Calculate Customer LTV
Using past data is one way to calculate the value of a customer. 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.
The data components you need to calculate CLTV are:
- 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 find the CLTV, you need to multiply the average customer lifespan by the value of your average sale, then subtract the cost of acquisition.
This provides the foundation for understanding CLTV at a high level.
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
Much like its name suggests, 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 multiple variable 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 discontinue 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 remaining customers at the end of a period from the total number of customers at the start of the period. This difference is divided by the total number of customers at the start of the period (including both acquisitions and renewals).
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 6%. The period you select to calculate your churn rate should be dependent on your typical customer contractual period.
There is a critical difference in how ACL is calculated between contractual business (like Victorious, which offers contractual SEO services), and non-contractual business (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 will need to clearly define a churn event. For example, if you’re an online retailer, you may notice that customers are likely to make an additional purchase within a certain period of time. You might define a churn event as a customer that has not made a subsequent purchase within this period of time.
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, 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 of a contract your customers have with you.
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 cost accrued 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 cost of customer acquisition.
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, some businesses may prefer using the Customer Value and Average Customer Lifespan (particularly product-focused businesses that prefer to leverage historical data).
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 instead of contractual 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 to 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 you’ve calculated your Customer Lifetime Value, what do you do with it?
Here are some options (this list is not exhaustive):
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 are worth.
While it’s crucial to understand which customers bring the most value, understanding which relationships are not benefiting the business is also important.
Understand Your Business
Customer Lifetime Value can also provide some analytical insight into your marketing activities. It can highlight 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 focuses instead on adding long-term value to revenue generation.
SEO and 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 as a marketer in influencing customer loyalty.
Ready for an SEO partner that will take the time to understand your long-term business goals?
We’ve got you covered.
At our SEO agency, we have a full suite of 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.