Why You Need to Know How to Calculate Customer Lifetime Value

Maintaining a business is no simple feat. But one of the important aspects of maintaining your business activities is understanding your customers' lifetime value and how to calculate customer lifetime value.

But really, when was the last time you calculated the customer lifetime value for your business or store?

If you're thinking "my what?!" and staring wide-eyed at the screen, fear not.

In this article, we're going to explain what customer lifetime value is and how to calculate it for your business.

What Is Customer Lifetime Value?

Customer lifetime value (CLV) or lifetime value (LTV) is a metric used by businesses and stores to measure the value of their customers in terms of the length of the relationship that customer has or may have with their store.

The CLV "represents the total amount of money a customer is expected to spend in your business, or on your products, during their lifetime," explains online store builder Shopify.

Basically it's a business's profit margin earned from each customer during the course of this customer's relationship with your store or business.

Calculating customer lifetime value is super important because it helps businesses make decisions about how much they want to invest in marketing and customer acquisition.

In other words, CLV includes: the costs of acquiring customers, the marketing spent on that acquisition, sales and operating costs, in addition to the cost of manufacturing the actual product or service you provide.

A lot, right?

Customer Lifetime Value Isn't a Short-Term Thing

Sadly many companies and online businesses struggle with and often neglect CLV and calculating customer lifetime value altogether.

Some are unfamiliar with the idea to begin with and others are unaware of how calculate CLV.

What these companies do instead is look at the short-term sale. The customer buys now.

Imagine spending $100 to acquire customer Marie who comes to your store and purchases a pair of running shoes worth $70.

What has happened here?

Not only has Marie spent less than what you paid to acquire her, but also doesn’t return to your store.

What does this mean?

You not only wasted $30 on a customer, but that customer's lifetime value is significantly short. They came in once, never to return.

While there are various methods of getting return customers, such as loyalty programs and referral marketing programs, they aren't the topic for today.

"It’s still important to find new customers for the growth of the company, but optimizing the lifetime value of existing customers is also essential for a company to sustain a viable business model," explains CleverTap. 

Why Do Businesses Struggle with CLV?

Many businesses struggling with calculating customer lifetime value because many "operate in disconnected silos," explains a report by Econsultancy.

It adds that this disconnecting results in a lack of integration and makes it difficult for businesses to manage CLV.

The report also notes that only 42% of companies are able to calculate and measure CLV!

How do I Calculate Customer Lifetime Value for My Business?

It's now clear that understanding CLV and learning how to calculate is of great importance to businesses.

By learning how to calculate customer lifetime value you can predict – in a way – how much a customer is worth to your business on the long-term.

Based on the above, to calculate customer lifetime value, you, as a business owner, need to consider a few points.

You need to create a set of assumptions to make this calculation.

These assumptions include the value of an average sale in your store, the duration of your business relationship with a customer, and the average number of transactions carried out by customer.

If your business has been around for some time, you can use your historical customer data to calculate customer lifetime value.

If you don't, it might be quite difficult and you may need to gather some data first.

To calculate customer lifetime value, you need to multiply the average value per sale, the average number of transactions, and the average customer retention period.

Here's the formula provided by CleverTap:

Customer Lifetime Value = Average Value of Sale × Number of Transactions × Retention Time Period

This CLV calculation gives you a gross revenue result, which means it doesn't take into account operating expenses.

As a business, you need to decipher how much you spent on the product or service, advertising, and management operations.

Once these elements are considered, you can update the formula of calculating customer lifetime value as follows:

Customer Lifetime Value = Average Value of Sale × Number of Transactions × Retention Time Period (in years) × Profit Margin

Example of Calculating Customer Lifetime Value

Imagine Steve, an athlete who buys 4 pairs of running shoes per year for 8 years. At the same time, Anna is a mother who buys her toddler 4 pairs per year but for 3 years.

Steve's CLV is:

$100 per pair of shoes X 4 pairs per year X 8 years = $100x4x8=$3,200

For Anna, on the other hand, the CLV is:

$20 per pair X 5 pairs per year X 3 years = $20x5x3 = $300

So who is a better bet and better customer for your business? Yes, it's Steve.

By knowing that Steve will spend an average $3,200 in your store over the next 8 years, you may be able to estimate how much you want to invest on marketing your products to Steve and similar buyers.

The Value of Understanding and Calculating Customer Lifetime Value

Now that you have the formula for calculating customer lifetime value and have an idea why you should focus on that, let's delve deeper into the importance of CLV.

In addition to helping you with your business's decision-making, here are 5 reasons, according to Shopify, that CLV can help you with:

• Shows you how much you can spend on marketing to different customers and maintain profitability
• What types of products or services do your high CLV customers want
• What products are more viable as repeat purchases
• Which products have higher profitability
• Who are your top most profitable clients  

With this information in mind, you can focus on driving revenues and profits to your store or online business.

Understanding CLV to Drive Loyalty

By understanding how customer lifetime value works and how you can calculate it, you can then focus on the types of products these types of customers want.

To increase the chances of them buying from you and to lengthen your long-term relationship with them, consider enrolling them in a loyalty program.

This way, not only are they interested in your products but you can keep them coming back to your store and worry less about them going to a competitor.

If you're store is on Shopify, check out Gameball's free and paid options.

You can also use Gameball with WooCommerce or directly via your website or mobile app.

Final words

Customer lifetime value isn't a new trend. It's been around for as long as businesses have been around.

But the biggest problem is that many businesses don't understand how it works or how to calculate it.

But as you can see, once you understand how CLV works and is calculated, you can aim to increase customer lifetime value for your store.