Customer Lifetime Value (CLV) is the predicted value a business can derive from their entire relationship with a customer. It is an important ecommerce metric you can use to understand your customers and to make important decisions on your sales, marketing and product development needs.
How much should you spend on marketing per customer? How can you offer your products that will suit the taste of your loyal customers? How much should you spend on services to retain your best customers? What are the types of customers you should spend the most time trying to acquire? – these are just some of the critical business questions that the lifetime value of a customer can answer with confidence.
In this article, we will show you how the lifetime value of a customer is calculated, why you should consider it an important metric, some tips you can apply to your own business to improve your customer lifetime value and its implications.
Lifetime value calculation – how it’s done
In contrast to other ecommerce metrics, calculating your customer lifetime value can be quite complicated. You need to consider many nuances based on the questions you want to answer.
Aside from using straightforward ways to know the lifetime value of a customer (like using this calculator for instance), you can use this very basic CLV equation in your computations:
CLV = (Average Value of a Sale) X (Number of Repeat Transactions) X (Average Retention Time in Months or Years)
For example, your customer spends 50 dollars a month on your products for two years.
CLV = 50 dollars X 12 months x 2 years
CLV = 1,200 dollars
While it is easy to compute, this customer lifetime value formula does not give you the whole picture. It is not enough to know the average; it is crucial to know your customers more and segment them according to the revenues they contribute to your business.
A more elaborate approach on lifetime value calculation is provided by KISSmetrics using Starbucks and its 2004 sales data, which we previously discussed in an article.
But for a recap, the first step to the tedious process is to lay down your variables – the amount a customer spent per purchase, the number of purchases a customer makes and the product of both variables.
The second step is to calculate the CLV in three different ways while referencing the following constants:
- Average Customer Lifespan (t)
- Customer Retention Rate (r)
- Profit Margin per Customer (p)
- Rate of Discount (i)
- Average Gross Margin per Customer Lifespan (m)
The three different ways the CLV can be calculated are as follows:
1 – CLV = 52(a) X t where 52 refers to 52 weeks in a year
2 – CLV = t(52 X s X c X p)
3 – CLV = m[r/(1 + i – r)]
You can read our article on startup metrics for a full illustration of how the CLVs for Starbucks were computed using the three formulas.
There’s also another approach to CLVs. If you want to know your CLV based on your net profit or how much exactly each of your customers are contributing to your business, you can calculate your customer’s historic CLV using the customer lifetime value formula below:
Historic CLV = (Purchase 1 + Purchase 2 + Purchase 3… + Purchase N) x Average Gross Margin
The beauty of using this formula is it takes into consideration customer service costs, costs of return, acquisition costs, costs of marketing and so on, giving you great insight on your customer’s true profitability and value to your business. However, the only challenging aspect to calculating historic CLV is it can be a lot of work especially if you want the numbers to be constantly up to date.
On the other hand, if you want to have an even more accurate CLV by predicting the total revenue a customer can contribute to your business over their entire lifetime, you can use predictive CLV with the customer lifetime value formula below:
Predictive CLV = [(T X AOV) * AGM] X ALT
T = Average monthly transactions
AOV = Average order value
ALT = Average customer lifespan (in months)
AGM = Average gross margin
As these are only forecasts, the accuracy and confidence you can place on your CLV should be taken with caution. Also, your customers are not all the same. You will see that some are more valuable than others as you gather more and more data.
Lifetime value calculation requires you to identify moments when profits are made. Organize your sales records well and measure profits made at each point.
Tracking lifetime value on Google Analytics
If you are not keen on predicting your customer lifetime value using any of the formulas that we just covered, you can identify your CLV on your Google Analytics account. And there are two methods you can use – using custom dimensions or custom metrics.
Although it sounds more appropriate to track CLV as a custom metric because it involves numbers, you can also use custom dimensions in conjunction with custom metrics. And there are advantages and disadvantages to using each.
The advantage of using custom dimensions is it can be used with data import. It can represent the CLV of a customer at any given time and is not dependent on the data range you will indicate on your report. And lastly, it is easier to get a distribution of your customer’s CLV with custom dimensions.
However, using custom dimensions won’t allow you to segment your users with greater than or less than a certain CLV and it also will not show you the average CLV per channel or region.
Using custom metrics, on the other hand, can show you the average CLV of your customers by segments. It can show you your CLV by channel and region and also your customers with greater or less than a particular CLV.
However, it won’t yield values if you have a long date range or if your site receives a sizable amount of traffic. Your CLV will likely be sampled and thus won’t be as accurate as you want it to be.
Adding the custom metric on Google Analytics
The first step is to go to your Google Analytics account. Under the Property column, click through to Custom Definitions then Custom Metrics. Create your custom metric for your CLV similar to the example below.
You will need to include the index of the custom metric also, which is any value from 1 to 20. This value will tell your Google Analytics where to store your CLV. Index 1 will be for your first CLV, Index 2 for your second, and so on.
Next, implement the code that will track your CLV on your site. On the receipt page where your ecommerce tracking code is also placed, include an extra line for the code that will set each of your order values as a custom metric.
Now that every order value you will be getting will be validated as a custom metric, you need to associate it with a specific customer. To do so, you need to create a unique ID for each of your customers using a user-scoped custom dimension as detailed in this article.
Once you have set up the unique ID, you can start creating a custom report of your CLV on Google Analytics similar to the illustration below:
Remember that values generated in this report will only include revenues generated within your specified date range. Revenues before and after the specified dates won’t be factored in.
Why lifetime value of a customer is important
We all know that acquiring new customers is more expensive than nurturing the relationships you have already built with your base. Moreover, the likelihood of selling your product to a new customer is five to 20%, but selling the same product to an existing customer is likely to happen 60 – 70% of the time.
Hence, your customer lifetime value is central to a sustainable business model and to your customer retention strategies.
So, why is this again important?
Because it helps you generate real ROI from your customer acquisition efforts. As it leads you to your segment of customers who contribute most to your profits, you can focus and optimize all your marketing efforts on them and make them your most profitable sources of income.
It is a sound business strategy to maximize your CLV with the cost of acquiring customers. When you focus on your CLV, you will not have any reason not to spend more on acquiring new customers because you are not held back by the profit from a single purchase, but from the purchases that will be made within that customer’s lifetime.
Because it helps you retain your best customers in the fold. When you recognize and know who to spend most of your marketing efforts to (meaning your best customers), then your best customers know that you value their patronage and loyalty. They will likely repay this and fulfill your conversion goals in the course of their lifetime.
Also, computing your CLV is a good indicator for improving customer service, efficiency and reducing customer dissatisfaction. When you understand your customers needs and behaviors, you can help improve their loyalty too for a longer period of time. Knowing your CLV also helps you measure and demonstrate the bottom-line financial impact of these efforts plus your marketing activities.
Because it allows you to create more effective marketing messages. It also helps in your targeting and nurturing needs. Personalizing the shopping experience is crucial if you want to win your customers and inspire their loyalty. Segment your customers based on CLV and based on the behavioral triggers that a particular segment has, offer them products that you think they will need and highly respond to.
Because it can also help you win back customers who have left. Knowing your CLV can go a long way not only in keeping loyal customers in, but also in identifying your churn or the rate at which your customers have stopped paying for your products and services.
By knowing your CLV, you can design new marketing programs and tactics that will reduce customer attrition. You will know the segment of customers you need to prioritize and win back, what strategies to design and what steps to take to make them interested again.
Because it gives you better forecasting. With CLV, you can plan for the better availability of products that will likely be demanded by your customers in the future. This prediction can help you manage better investment in assets and inventory based on estimated demands. You can better allocate your resources, which will help you cut down significantly on productivity loss. Likewise, if you have multiple product categories in your inventory, CLV can help you predict purchase probabilities in each category and allow you to efficiently allocate resources, translating into higher profits.
Tips to improve your customer lifetime value
There are plenty of ways to increase your customer lifetime value, but regardless of the strategies you will implement, you need to maintain a steady and recurrent cash flow from your best and loyal customers.
Make certain products appear necessary. Sometimes, customers purchase products when it looks like they need it. For instance, if you are selling laptops, make the purchase of a screen protector or a laptop bag a must to your customers. You can make a good deal out of it to your customers by offering them a small discount for bundling.
Recognize your customers and put them on the spotlight. You can make the reviews your customers have submitted a highlight of your product pages or on your official social media accounts. Everyone loves being recognized, so make it a part of your marketing efforts to put your customers under the spotlight.
Listen to your customers. One of the best ways to nurture customer relationships and inspire loyalty is to value their feedback and opinions. Have a growing sensitivity to your customers’ needs, be proactive and respond to them immediately. Never allow an issue to escalate.
Make it convenient to do business with you. And if you are an ecommerce site, optimize your store for easier shopping and checkouts. Ensure that your site loads fast, your system can store previous customer information like shipping addresses and credit card details, and keep your forms short so it’s easy to accomplish and submit. And more than the shopping experience, make it convenient for your customers to reach out to you as well.
Invest on your products’ quality. Making your products stand out and always in excellent quality can inspire customer loyalty and increase customer lifetime value. Nothing can help you outpace your competitors significantly when quality is your key selling point. And when quality becomes synonymous to your business, you can create a fan frenzy around your products that will boost your sales dramatically.
Give your customers surprises. Fantastic customer service can go a long way when it comes to your customer lifetime value. Delight them with small surprises every now and then like free shipping, birthday coupons, birthday greetings, retweets, thank you messages and holiday postcards. When your customers feel your effort to get to know them, they can repay this with a lifetime’s worth of loyalty.
Personalize the shopping experience for them. As mentioned earlier, personalizing your customers’ experience of your site goes a long way in keeping them interested and satisfied. Integrate the necessary software that will help track your customers’ browsing behaviors so you can upsell and cross-sell items relevant to what they have in mind.
Keep your word. Especially when it comes to promises you make on shipping and deliveries, failing to keep up with what’s agreed on may hurt your customer lifetime value. Provide order tracking and send texts to your customers about the latest status of their packages.
Reward frequent buyers. Special membership programs can do wonders for customer lifetime value too especially for regular shoppers. You can implement a program similar to Amazon Prime where customers can have free shipping within two days and unlimited access to products for a year for a fee of 99 dollars. The upfront cost may be expensive, but there are savings to be had on shipping costs throughout the year.
It is a challenge for many businesses to estimate who their best customers are over the customer’s lifetime and to know how the most valuable ones behave.
Customer lifetime value helps you solve these challenges by defining the financial value of each of your customers, guiding you come up with strategic customer relationships and optimizing your customer engagement practices.
With your comprehensive sales data at hand, use any of the customer lifetime value formulas we just discussed to know your customers’ worth to your business. And if you are using Google Analytics, track your CLV there too by creating a custom metric and placing the proper code on the backend of your site. Keep in mind the different ways you can boost your CLV and make sure to read your numbers after every implementation to see if these are working to your advantage or not.
The beauty of customer lifetime value is it spans all industries. Use it to grow your business and see the revenue growth opportunities that await you.