This article was originally published in 2018. It has been updated with relevant information for 2020.
The importance of Customer Lifetime Value (also called CLV, CLTV, LCV, or LTV marketing) has been understated for a long time. CLV is the most important metric that companies ignore. Marketers have been writing about how important knowing CLV is for years, and it’s still being ignored or underutilized: a UK study found that only 34% of the marketers they surveyed were “completely aware of the term and its connotations.” And only 24% of respondents felt their company was monitoring CLV effectively.
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What is Customer Lifetime Value?
The definition of Customer Lifetime Value is simple: Customer Lifetime Value represents a customer’s value to a company over a period of time. You can calculate a simple Customer Lifetime Value model for your company with this formula:
There are other methods of calculating CLV that get much deeper and can focus on the individual customer. In this article I’m going to move straight into the importance of Customer Lifetime Value, and the actionable ways you can use it to improve your business. If you’d like more background on the metric or ways to calculate it, I recommend this write-up from the Harvard Business Review.
Why is Customer Lifetime Value Important in 2020?
CLV Informs How Much You Should Spend on Customer Acquisition
Your customer acquisition costs may very well equal more than you make from a first purchase, but are you still making money from that customer in the long run? Figuring out the lifetime value of a customer to your company will give you the answer.
CLV Allows You to Segment Your Customers Based on Value
Using CLV, you can better understand the different personas among your customers; the first step to effective targeting or personalization.
You can narrow your focus: send a special offer or gift to your “VIP” customers to make sure you retain them, or focus on acquiring new customers with similar backgrounds using look-alike modeling. You can start slowly upselling less valuable customers to increase their CLV. This segmentation allows for a personalized experience; something many customers now expect.
Focusing on CLV is Key For Long-Term Company-Wide Growth
It’s a competitive market for e-commerce companies in 2020, and price isn’t the only determining factor in a customer’s decisions. CLV is a customer-centric metric, and a powerful base to build upon to retain valuable customers, increase revenue from less valuable customers, and improve the customer experience overall.
The Process of Finding Your CLV is Valuable
The advantage of determining customer lifetime value is not just the final number itself, but also the thinking and calculation behind the metric.
It’s about Customer Lifetime Value meaning more than any one statistic. Finding your Customer Lifetime Value will make you think, not just about the sale, but about the full customer journey: when, where, why, for how much, and how often do your customers make a purchase. Answering these questions will bring valuable insights, and help you spot issues you may not have noticed before.
How Do You Calculate Customer Lifetime Value?
There are four KPIs that determine your LTV: Average Order Value (AOV), Purchase Frequency (F), Gross Margin (GM) and Churn Rate (CR). It’s important to look at each of these individually to find out which one needs the most work in terms of profit maximization.
How to calculate your Average Order Value (AOV)
AOV = Total Sales Revenue / Total Number of Orders
Average Order Value ANALYSIS: Company A
Total Sales Revenue (annual): $1,000,000
Total Number of Orders (annual): 40,000
1,000,000 / 40,000 = 25
Company A has an Average Order Value of $25
How to calculate your Purchase Frequency (F)
F = Total Number of Orders / Total Number of Unique Customers
Purchase Frequency ANALYSIS: Company A
Total Number of Orders (annual): 40,000
Total Number of Unique Customers (annual): 15,000
40,000 / 15,000 = 2.67
Company A has a Purchase Frequency of 2.67
How to calculate your Gross Margin (GM)
GM = Total Sales Revenue – Cost of Goods Sold (COGS) / Total Sales Revenue (express the result as a percentage).
Gross Margin ANALYSIS: Company A
COGS = Beginning Inventory (inventory left from last year) + Additional Purchases During Period Cost – Ending Inventory (inventory left at the end of the year)
Beginning Inventory: $180,000
Additional Purchases During Period: $450,000
Ending Inventory: $160,000
180,000 + 450,000 – 160,000 = 470,000
Company A has a Cost of Goods Sold of $470,000
Total Sales Revenue: $800,000
800,000 – 470,000 / 800,000 = 0.41
Company A has a Gross Margin of 41%
How to calculate your Churn Rate
Churn Rate = (# of Customers at End of Time Period – # of Customers at Beginning of Time Period) / # of Customers at Beginning of Time Period
How to calculate Customer Lifetime Period (1/Churn)
Customer Lifetime Period = 1/Churn Rate
Customer Lifetime Value ANALYSIS: Company A
Average Order Value: $25,
Average Purchase Frequency: 2.67,
Gross Margin: 41%,
Churn Rate: 60% -> Customer Lifetime Period: 1,67
25 (AOV) * 2.67 (F) * 0.41 (GM) * (1/0.6) = $45.7
Customer Lifetime Value is $45.7 (per customer).
How to Improve Your Customer Lifetime Value (LTV)
With our KPIs ready, it’s time to work on our customer value maximization. But, what is a good profit margin? What is a good purchase frequency? (Don’t forget, a good retail profit margin wouldn’t necessarily be a good food services profit margin).
Compare your KPIs with industry benchmarks to determine which KPI needs the most improvement. Find current averages for your specific industry, then get to work. Which one could improve customer value the most? Remember to focus on your weakest KPI first in order to maximize profit.
How to Improve Your Average Order Value (AOV)
Having trouble getting your customers to increase their spending? Try these campaigns, which focus on providing incentives to increase average order value.
- Add personalized product recommendations to the site; the recommended products should be based on the ideal price point for each individual customer, thereby maximizing revenue.
- Send personalized newsletter campaigns with dynamic product recommendations optimized for price.
- Trigger product recommendations, based on what they’ve added to their shopping cart, directly on the site.
- Send an email campaign with product recommendations based on what they’ve added to their shopping cart.
- Create product bundles that offer a discount for making a larger purchase. Bundle products that can be used together, and recommend the bundle directly on the site, or through email, based off the user’s browsing and shopping cart history.
- Create a customer loyalty program, incentivizing spending by adding loyalty points that customers can use for discounts and freebies.
How to Improve Your Purchase Frequency (F)
Maybe your customers spend a lot, and you’re making a great margin, but they just don’t order very often. Try a few of these campaigns to maximize profit by getting your customers to pick up the pace.
- Communicate dynamically. Using historical customer data collected with a true unified Single Customer View, you can automatically send emails that arrive at the ideal time for each individual customer. (Make sure those emails are personalized!).
- Find out if you’re communicating through the right channels – does this particular customer respond better to email or SMS? Make sure each customer receives your message through their preferred channel.
- Segment your customers by their customer lifecycle stage, then re-engage with customers who haven’t purchased in a while, and are in danger of churning.
- Use push notifications and banners to highlight time sensitive deals based off their browsing history.
- Use banners that trigger when a customer enters and exits the site. Use these banners to recommend personalized products or sales.
How to Improve Your Gross Margin (GM)
It doesn’t matter how valuable your orders are or how frequently they happen if your Gross Margin doesn’t allow for a profit from the sales. Here are some ideas for profit improvement through increasing the revenue you make on the sale.
- Use an Inventory Manager to make better estimates for what you’ll need to resupply your stock for the next year.
- This is an easy one for maximizing profit margins: sell higher margin products! You can adjust your recommendation models to exclude products that are hurting your margins.
- Use a Price Optimizer to automatically find the ideal selling price for each of your products, based on where they are in the product lifecycle. This will inform you of any products with more room for profit maximization.
- Reduce your Cost of Goods Sold by selling the products left from the previous year.
How to Improve the Churn Rate (Customer Lifetime Period)?
Churn is a very complex metric, and there are many factors that combine to cause a customer to churn from your business. To decrease churn, you need to mainly focus on customer loyalty. Create incredible shopping experiences and your customers will stay with you.
How to Improve Your Customer Lifetime Value (Videos):
Uncovering Opportunities to Increase Customer LTV:
(Note: This video uses a simplified version of the CLV formula)
Increasing Customer LTV One Campaign at a Time:
From Visitors to Star Customers (Exponea Webinar)
How to Use Customer Lifetime Value
In order to get the most out of CLV, some of the specifics discussed in this article are a must.
Once that’s in place, there are numerous actionable uses for the metric. Using CLV effectively can improve customer acquisition and customer retention, prevent churn, help you plan your marketing budget, measure the performance of your ads in more detail, and much more.
Here are a few of our favorite ways to use CLV:
1. Acquire Higher Value Customers
Once you’ve performed a CLV analysis on all your current customers, you’ll know how much it makes sense to spend on acquisition. You’ll also know which acquisition channels produce the highest value customers, and can repeat the strategies you used to find them.
2. Secure Future VIPs
Once you have a solid data profile of what characteristics your VIPs have, you can use predictive analytics to get a strong idea of which new customers will likely be future VIPs, and focus on these customers with personalized messaging and offers You can also make use of a look-alike model, as was mentioned in the first section, to target similar profiles.
3. Practice Value-Tier Segmentation
We touched on this in the first section. CLV makes it possible to identify which customers are VIPs and which are lower value. Once you separate your customers into different value tiers, you can see where your money is really coming from. Look at your VIPs, the 5% on top: how much of your total revenue is provided by just this 5% of your customer base?
With defined levels of customer value, you can then focus on converting customers from their current tier to a higher one.
4. Prevent Churn
Now that you now know the Average Order Value and Purchase Frequency of your customers, the door is open for personalized messaging to send the right offer to the right person at the right time.
5. Find Your Weak Point – Then Strengthen it
The insights gained from calculating your CLV will lead you to where problems can be found in your company: you’ll be able to see which area you most need to invest your time and money into.
6. Plan Your Yearly Advertising Budget
If you know your CLV, you can figure out how much you can spend on acquisition while remaining profitable. This, in turn, allows you to determine how much you’ll need to spend on advertising much more precisely.
7. Measure Your Ad Performance
Without CLV, you’re relying on the profit from the first purchase to tell you which customer is more valuable. Take this Customer Lifetime Value example: Jim spent $6 and Billy spent $15 so Billy is the kind of customer we care about. But after measuring for CLV, you may find that Jim makes multiple purchases a month, while Billy is never seen again.
Now you know that the ads you invested in to acquire Jim can actually create more value than the ones that acquired Billy. Scale that with the data of all your customers, and you get the full picture of which ads are most effective for your business.
CLV – Part of the Most Important Formula in Online Retail
Understanding Customer Lifetime Value is critical in its own right. But it also plays a key part in the Holy Grail of retail math, the most important formula in online retail. This equation is so critical that here at Exponea, we simply call it the Online Retail Formula.
CAC < LTV
Simply put, if you want to know if your e-commerce business is in good shape, you need to make sure your Customer Acquisition Cost is lower than your Customer Lifetime Value. We break it down for you in a short video below.
(Note: This video uses a simplified version of the CLV formula).
Why Does Customer Acquisition Cost (CAC) Matter?
Customer Acquisition Cost (CAC), as the other half of the Online Retail Formula, is a crucial metric to understand. You need to know how much you can spend to acquire enough customers, without spending more than those customers will bring to your company.is
CAC is the cost of getting a new customer to buy your product or service, and it consists of the ratio between two components:
- The sum of all costs spent on acquiring customers for a given period
- The number of customers acquired in that same period
You want to reduce your CAC as much as possible, while also increasing your LTV. We’ve prepared strategies to reduce your CAC – check them out and see how many of them you’re already using.
Customer Lifetime Value Applied (INTERVIEW)
Exponea clients like Desigual use CLV to drive critical KPIs for their business. We sat down with Ricardo Gómez, Global Head of 365 Consumer Marketing at Desigual, to understand how Desigual improves their CLV. Read the interview or check out some excerpts here.
EXPONEA: What is more important for Desigual: lowering customer acquisition cost or increasing customer lifetime value?
RICARDO: For us, increasing CLV is what matters the most. Our CAC is quite low compared to the business our customers bring to the brand. The biggest acquisitions we do are done when our customers buy and we invite them to join our members program. This is why we have to ensure we’re driving traffic to the stores and increasing the CLV of our database.
EXPONEA: What have you found to be the most challenging part of increasing your customers’ lifetime value?
RICARDO: Our CLV is very linked to the overall experience we offer and to the quality of the products we sell. Therefore, we largely increase our CLV by making sure there are no pain points, or if there are, that we address them quickly. We also do not send campaigns for products that have had or could have any quality issue.
Omni-channel campaigns are important too; we run several campaigns to move clients who shop offline only to buy online as well. This has a great impact for us.
Finally, we found a correlation between lowered customer value and lower quality purchased products, so we stopped communications around those items, and began to remove the garments we believed to be below our standards.
Why Don’t More Companies Use Customer Lifetime Value Effectively?
Many Established Companies Keep Their Data in Different Silos
As companies grow, it’s common for their data to become fractured; different pieces kept in separate places (often using different software) as each department pursues its own goals. This makes collaboration more difficult, and can result in less trustworthy data if the same information is stored in two places without an effective time-stamp to show which is more current.
The old model for finding ones’ most valuable customers was through RFM analysis: examining the Recency of a customer’s last purchase, the Frequency with which that customer makes a purchase, and the Monetary value of their purchases. RFM analysis is still what’s used by most companies looking into this metric; even with the data separated into silos, an RFM analysis is still possible.
But we know a lot more about our customers in 2020.
One major disadvantage of the RFM Models is that they’re very rigid, mostly unable to utilize the rich data that companies today have on users’ behaviour and engagement.
Siloed data also gives reason to why only 24% of respondents in the previously mentioned study believed their company was monitoring CLV effectively: without unified customer profile data, it’s nearly impossible to get the sort of actionable results you want. In order to make use of the wealth of data that’s been collected, you need a CLV model that utilizes Machine Learning methods to make it predictions. And that’s just not possible with siloed data.
Customers Now Make Purchases From Multiple Devices
With the same customer making purchases from their computer, phone, and tablet, many companies have difficulty combining all the data streams into one measurable whole. Attempting to extract meaningful insight from these separate streams can be both expensive and inefficient. Companies without a main dashboard synthesizing all customer data in one place are finding themselves increasingly left behind.
Further Reading: What’s a Customer Data Platform?
Companies Lack In-House Skills
Many companies who have not yet begun tracking CLV are dealing with a lack of qualified personnel to follow the data and produce actionable plans based on it. This, coupled with the need for an in-house dashboard for that qualified personnel to use, creates a strong barrier to entry.
Determine Your CLV With a Customer Data Platform
Today’s marketers, data scientists, executives, and other professionals now have a powerful tool to help them determine and utilize customer lifetime value: a customer data platform (CDP). A CDP serves as a central hub for all your customer data, collecting it into individual profiles for each customer.
A CDP is an excellent tool for calculating CLV, since it has all the key components of the formula in one place. Some CDPs even offer CLV as an out-of-the-box metric.
The best CDPs will make it easy for you to activate your CLV data within the platform. With a good CDP, you should be able to segment your customers by their lifetime value, then send automated personalized campaigns to those different segments.
If you are considering a CDP, we have prepared a CDP selection guide to help you with the process. Experts from Exponea weigh in on what makes or breaks a CDP project – give it a read to make sure you’re on the right track.
Most major companies realize the importance of Customer Lifetime Value, and are slowly getting better at using it effectively. To save time and money, many of these companies have begun partnering with SAAS companies, whose tech is ready to be implemented. If you’d like to hear how Exponea, as one of these SAAS companies, can help your company, please be sure to contact us. If you want to see our tool in action, check out this 3‑minute demo video.