Every business has its own way of calculating the profits and how much money do they need to distribute for their current and future business cycle to happen.
But, knowing how valuable your one customer is to your business you need to know its lifetime value. Thus, knowing Customer Lifetime Value helps you get a better idea in many prospects and how it would help you scale up your business.
Let us first understand the concept of Customer Lifetime Value.
What is Customer Lifetime Value (CLV)?
A Customer Lifetime Value or the lifetime value of a customer simply means the total revenue that is the net profit you would receive from a single customer throughout your business cycle with them. It is an important metric that you must calculate in order to know what is your Cost per Acquisition (CAC) for a customer.
It will help you understand that you shouldn’t be spending much after that cost incurred to acquire that customer. Nobody would want to suffer any loss in their business!
Why is knowing Customer Lifetime Value important?
Customer Lifetime Value is extremely important to your business as it helps you structure your customer acquisition cost, making you spend the necessary amount and cutting down the unwanted costs that might neither help to acquire any new customer nor retain your current customer.
CLV is a very important metric and is used while making important decisions about sales, marketing, product development, and customer support. It helps maintain a better lifetime relationship with your customers.
Even if you are looking out to start your new venture, you need to know whether it will be turning into a profitable business for you or not. Nobody wants to start a business that will be eventually turning into a non-profitable company due to poor money management.
Knowing your CLV, it helps you decide your business strategies accordingly. It isn’t easy to acquire new customers and anyone would want quality customers over quantity.
It’s better to acquire 100 loyal and paying customers rather than acquiring 500 customers just to make your brand look great with high numbers. They won’t be bringing any money to your business.
How do you calculate CLV?
The easiest way to calculate Customer Lifetime Value for any customer is:
Customer Lifetime Value = average value of a purchase X number of times the customer will buy (each year) X average length of the customer relationship (in years)
For example, if you own an online clothing store or want to start a clothing store but are confused about who should be your target audience – check these two CLV values to understand better.
(Case A) – A woman spends $50 for clothes X 10 times in a year X 3 years
CLV = $100 x 15 x 3 = $1500
(Case B) – A teenager spends $15 for clothes X 8 times in a year X 3 years
CLV = $30 x 8 x 3 = $350
Who is more profitable here? Definitely Case A.
Now, calculating CLV helps you determine your business module and how much profit you will be earning after spending a certain amount on customer acquisition and retention.
Spending more than an average of $1500 (in Case A) on Facebook ads, Google ads, or any other marketing method per customer throughout your business would only cause a loss for you.
Let’s take on another example which relates to our everyday lives –
(Case A) – Mr. Richard (aged around 45) spends around $5 for his coffee at your cafe shop X 20 times a year X 2 years
CLV = $5 x 20 x 2 = $200
(Case B) – Ms. Ellen (aged around 30) spends $5 for her coffee X 60 times in a year X 2 years
CLV = $5 x 60 x 2 = $600
Again, you know who will be more profitable to your Business – Case B
Ms. Ellen loves your coffee more!
This also helps you narrow down your target audience. You can also categorize them as per their age as that would again help your show ads specifically to that age group and convert them to your paying customers.
You can always try A/B split testing for 1-3 months or higher depending upon your final budget after calculating the CLV.
All-in-all this helps you structure and organize your business plans thus minimizing any risk for the loss.
Will there be any issues if you don’t have a Customer Lifetime Value calculated in your business?
For small companies, it is easier to calculate the customer lifetime value because of a smaller database vs a huge company who has millions of customers as it gets more difficult to keep an exact record of CLV for each customer.
Also, there won’t be any specific issue if you don’t want to calculate the CLV but doing it would only help you structure your costs and help avoid spending unnecessary extra money into the ads.
Acquiring a new customer can be a costly affair. In fact, an article published by Harvard Business Review found that gaining a customer can cost anywhere between five and 25 times more than retaining an existing one.
Additionally, a study conducted by Bain & Company found that a 5% increase in retention rate can lead to an increase in profit between 25% to 95%.
But in the end, your business does need customers that would help you grow your business right? And for this, knowing Customer Lifetime Value helps you maintain the proper costs to avoid any loss.
But what will be benefits of knowing Customer Lifetime Value for your business
As I had mentioned earlier, starting a business is all about reaching the first break-even point and slowly turning them into profits. But, if you cannot even break-even in your business, this is when knowing the customer lifetime value would play a big role in managing the money spent on growing your business and understanding more about customer acquisition costs.
Understand how knowing your customer lifetime value would be extremely useful to you and can help you determine a lot of these things
- The amount you need to spend to acquire one customer and still maintain a profitable relationship
You do not want to spend $5 per customer while you earn only $4.99 from them. Every cent counts and investing anywhere above the income would be a bad idea for your business. Having a profitable relationship with your customers will help you develop your business. Only then you will be able to set a higher margin for acquiring more and more customers.
- Know your ‘cost per customer acquisition’ cost
This is really important for you to be able to run your business successfully. Every penny counts and thus even if you are spending a dollar to acquire a new customer, your returns should be more than what you have spent to acquire them. Knowing your CPC is extremely important to determine the lifetime value of your customer. You can never spend more than your cost per acquisition for a customer. A well-balanced cost structure is important and for that, you need to know your customer’s lifetime value.
- Different ‘Customer Satisfaction’ ways you can add boost up your CLV
Customer service should be your top priority if you plan to run a business or is already running one. If they are not happy, they won’t invest their money on your products anytime.
If you have an offline store – a nice management team, cozy indoors and customer service is one sure way to make your customers feel special. This leaves a positive impact and it helps them to make a positive decision for making a purchase in your store.
If you run an online store – Having a great User Interface (UI) and User Experience (UX) is the most important way to get brownie points from your customers. They don’t want a heavy loaded website but instead a clean and easy to use UI that’s mapped out well without glitches. Here, this would help them spend more on your products and thus generating more revenue.
You only do well when you listen to your customer’s needs.
- Knowing your Customer retention cost.
Knowing your customer lifetime value also lets you set your customer retention cost. This way, your business identifies and nurtures the most valuable customers that interact with your company and help you increase your total revenue. You would know what limit to set to target your customer again and making them do a purchase with you again.
- Which products will help you generate more revenue
Once you know your customer lifetime value, you would also know the products they buy every time. If you have 10 varieties of coffee drinks in your cafe shop, you would want to know which one is a hot seller and which one is the least sold. This lets you plan out more strategically and helps you focus more on products that are generating higher revenue for your business.
- Who are your most profitable clients
Knowing the lifetime value of your customers helps you know who are the top spenders in your firm. You may arrange something special for them like a reward or create a certain special product for them to make them feel the luxury of purchasing from your business. It all depends upon the niche and how much the lifetime value you get of your customers.
- What offers you can introduce to boost your customer’s lifetime value
If you are already running a business, you would know why do your customers love your company. And, as they want to purchase more, there may be certain rewards or bonuses that they would expect from your business in order to spend more.
Here, you can try and test a lot of customer satisfaction ways that would work for you and help you bring in more paying customers. Let me tell you the top three rewards that would always work.
- Referral Programs – This is one of the best ways to bring in more new customers and sales. The referral bonus could be in any form like cash discounts, credit points or coupon code. Referral programs are one sure way to acquire new customers thus helping boost the lifetime value for that customer.
- Special Discounts – People who buy from you know the best season when you would offer them a discount. Setting any form of a special discount will help bring in more sales thus generating more revenue from that customer.
- Cashbacks – This is again one of the most interesting ways to engage your customers to buy from your website than your competitors.
For example, you have a coffee shop – you offer a 5% cashback up to $5 on a minimum value purchase of $50. Here the user is saving that $2.5 which is still better than saving nothing if purchased from your competitor’s shop.
All-in-all these special rewards will help increase customer satisfaction which is very important for any company to grow further. So make sure to reward your customers in any form that would eventually increase their lifetime value.
- What you can upsell to your customers
Knowing your customer’s lifetime value, you can also think of different ways to upsell them more products. If a customer is spending $10 with you on a product, you can target them and upsell them with your different products.
If you run a SaaS Security company that offers three different solutions for website security, if a customer is purchasing a yearly subscription for the first solution, you can always strategize and upsell them the other two solutions as well.
CLV lets you know what budget do your customers have and how much are they willing to invest in your products.
- How can you create a great customer support relationship with each customer
Having a great customer support relationship is also one of the most important factors for your company to survive. Every customer is important to a business and they would love to see you attentive towards them.
If you know the CLV for your business, you would understand how a great customer relationship would positively affect your sales and boost up your profits thus increasing the customer lifetime value overall.
Considering all these factors, knowing your customer’s lifetime value can surely be regarded as an important factor for your business. You can only have a successful business if you have a great customer retention and service score. Paying customers will help your business grow and develop further leading to a profitable business run throughout.