What is Customer Lifetime Value (CLV) and how can it be optimised?

What is Customer Lifetime Value?

Customer Lifetime Value (also known as CLV or LCV) is a measure that is often misunderstood and, even worse, completely overlooked by most businesses.

Customer Lifetime Value is the value of the benefits generated by a given customer throughout the duration of their commercial relationship with your company.

Therefore, it is generally defined as the value (in euros, dollars, or in your local currency) of the net profit you can expect from him.

But why is it being overlooked by businesses when it's so important? We're going to look at that in more detail right away.

Why is CLV important?

CLV is an important metric because it provides you with a customer-centric dimension to guide the essential marketing and sales strategies of your business.

The Customer Lifetime Value projection provides companies with important information for making decisions about their critical activities:

• Development of your products or services : CLV metrics are taken into account in decisions and how to incorporate customer feedback into product development. For example, you can decide whether it is profitable to make major changes to a product or service to satisfy the demands of a small customer segment or not.
• Marketing and Sales : Knowing a customer's CLV can help determine if acquiring new customers provides a sufficient return on investment (ROI). Marketing and sales strategies are ineffective if the marketing and commercial costs of acquiring a new customer exceed CLV.
• Customer Success : Increasing customer satisfaction is statistically one of the best ways to keep your most valuable customers and increase CLV. According to the Harvard Business Review, it's five to 25 times more expensive to acquire a new customer than to keep an existing customer. In addition, a satisfied customer is much more likely to recommend you to his peers (zero acquisition cost), which therefore impacts your Acquisition Cost and therefore your profitability.

Depending on the company, it is possible to use several types of CLVs based on historical data (current and past) but also on predictive data.

Customer Lifetime Value Approaches

There are various ways to calculate CLV, which can be divided into two categories:

Customer Lifetime Value “History”

A customer's historical CLV calculates what they spent on a company's services or products. There are two ways to calculate historical CLV: using ARPU (Average Revenue per User) or using cohort analysis.

ARPU

Here is how to calculate the ARPU that will serve as the basis for our CLV calculation.

It is a calculation that is still relatively simple

Cohort analysis

Cohort analysis allows you to calculate ARPU per month for all customers who first engaged with your business in a given month. It is a visual representation of all the variations over the months/years of the customer's life in your business.

The CLV calculation does not take into account customer behaviors, developments and preferences.

Customer Lifetime Value “Predictive”

The CLV predictive model is more complicated than its historical counterpart. The predictive CLV model uses historical customer behavior and estimated retention to estimate future customer lifespan and revenue using artificial intelligence and machine learning.

This model, by nature, takes into account customer trends and behaviors throughout their lives.

Focus on the formulas and steps for calculating CLV

Since CLV is a financial projection, it requires the company to make informed assumptions or to use historical data accurately.

Businesses that have existed for many years thus have more historical data on their customers and can calculate CLV more accurately.

Conversely, some companies that are still young need to use data and technology to predict purchasing behavior.

Now, it is sometimes complicated to find your way around the Web to understand Customer Lifetime Value because there are many different formulas that do not include the same variables, in short... it's often a jungle to find your way around.

Let's take a look at what explains these differences and what formula to use for your business.  

Why are there so many formulas for calculating CLV on the web?

Type CLV on Google and you may find yourself a bit lost between LTV or CLV but also between the many different formulas to calculate it. What about the true or false of these often different formulas cited in numerous articles or websites - which often offer partial and incomplete explanations on this subject.

Let me explain why we have so many ways to calculate and why they are all the same: it's just a matter of initial assumptions and what you expect from them 😀. It's gone!

Factors that impact CLV

CLV is a variable that depends on many factors, which is why you can find numerous formulas on the Web. Let's see the one that does (not) appear in all these formulas:

1) All the commercial and marketing and commercial costs invested to attract, convert or retain customers

2) Sales made by existing customers or the prediction of future sales (existing or new customers) based in particular on:

• Digital behavior
• Upgrading products or services
• Cross-selling/complementary
• The type of products or services

3) The rate of attrition (or conversely the rate of retention)

4) General costs (rent, equipment, etc.)

5) The discount rate, also known as the “Discount Rate”

• Consider that €100,000 in sales will not have the same value in 30 years as today: to do this, we introduce the concept of discount to estimate the change in value between a moment (T) and (T + X Years)
• This concept is generally not widely used because the period used to calculate CLV in general is little affected by this type of variation. (It is then considered that it tends to 0)

Now let's see what components influence CLV for current or future sales.

Components of current or future CLV parameters

Below is a diagram that should help you understand what is involved in calculating CLV.

In order to better understand your business, it is important to have data on which to base your decisions. It is therefore essential to have the right tools to track the behavior of your prospects and customers to understand how to maximize your CLV in the future.

Formulas for calculating CLV

We will now see together the 2 forms of LTV calculation:

• “Simple” formula
• “Complete” formula

Use this sample spreadsheet to test these 2 formulas and set up your own

Take a look below based on your specific needs, which option is best suited for your business.

Simple formulas

The first “simple” CLV formula is a very simple calculation to perform and can be done quite quickly - it is therefore worth knowing it as a basis for quick calculations.

This formula assumes that the revenues and costs incurred remain constant throughout the duration of the relationship with the customer.

Note: While the company's customer base share in the customer's lifespan changes little, this basic formula is in fact quite accurate.

LTV formula (basis for calculating CLV)

LTV is calculated in terms of gross revenue but does not include operating costs. How much did the development of the product or service, advertising or even management costs?

Take these costs into account when calculating CLV by attributing these costs to the margin earned.

CLV “Simple” formula

CLV corresponds to all of the benefits generated by a customer over the course of their lifespan.

So the simple way to write it is as follows:

Let's take an example:

Average sales at a clothing store are $80 and, on average, a customer makes purchases four times every two years. The lifetime value is calculated as follows: LTV = €80 x 4 x 2 = €640.

In addition, the clothing store's profit margin is 20%, resulting in a CLV that is as follows: CLV = €80 x 4 x 2 x 20% = €128.

The lifetime value figure can help a business estimate future cash flows and the number of customers it needs to obtain to achieve profitability.

Complete formulas

The second formula is to calculate net cash flow (that is, revenues and costs associated with the customer) each year and is generally recognized as the admitted/formal approach to calculating CLV.

On the other hand, if your annual turnover per customer is not relatively stable, a more thorough CLV equation is necessary. This traditional version of the formula takes into account the discount rate and provides a more precise understanding of how CLV may change over the years. This formula is generally recognized as the accepted/official approach for calculating CLV.

CLV “Complete” formula

The detailed CLV equation breaks down the individual costs and benefits for each year. Here's what you need to know to calculate it:

• Average gross margin per customer lifetime
• Customer retention rate
• Discount rate

Here's how it works:

As a reminder:

The formula can therefore also be written in this way:

This second calculation is a bit more complex, but please note that there is a model to help you and save a lot of time

CLV applications

Knowing the CLV allows you to develop brand, business development and forecasting strategies, to name just a few. Let's look at some applications of CLV:

Boosting retention and loyalty

The CLV is an indicator of how satisfied customers are with your services. The more a business knows about its customers and what interests them, the more likely it is to maintain lasting relationships with them. CLV helps businesses prioritize their efforts to acquire high-value customers.

Demand and sales forecasting

This is particularly important for retail and e-commerce businesses. By considering their CLV, businesses can better predict future demand and inventory. This allows for efficient allocation of resources.

Customer segmentation

CLV helps businesses identify their most valuable and loyal high-level customers. Businesses can use this data to reallocate resources to engage and retain these customers while developing a strategy to move lower-tier customers to the next tier.

CLV Optimization Strategy

There are two ways to grow your business.

• The first is to acquire new customers.
• The second is to focus on retaining your existing customers and increasing the length of time they will be linked to your brand (CLV).

A high CLV means that each customer will bring more revenue to your business. As each customer is increasingly valuable, that means your business can afford to spend more to acquire and keep current customers.

Below, we've listed a few tried and tested tactics to increase your average CLV and get more out of your existing customers.

Create a loyalty program

By encouraging regular purchases, you automatically increase customer loyalty and the value of their purchases throughout their lives. Repeat customers are always more profitable than those who only make one purchase, and retaining them costs less than acquiring a new customer.

Improving Customer Relationship Management

By providing better customer service and a consistent user experience, you'll keep your customers happy and extend the average lifespan of your customers. It also allows you to detect additional sales opportunities (cross-selling, upgrades, etc.), which would further strengthen your CLV.

Target your most valuable customers

When you calculate your CLV, you can identify the most profitable type of customer and use that information to improve your CLV in the future. Refine your marketing to target the most profitable customers who are more likely to make significant, repeat sales throughout their lives.

Educating customers

Another strategy that helps build long-term loyalty is to implement product training programs for your customers.

Customers may be hesitant because they don't see the value you want them to value your product, which is why training, documentation, and tutorials go a long way in helping them realize the value of your product.

They require customers to stay longer and increase the value of the product throughout its lifespan.

Add a personal touch

Customizations, along with an intuitive user interface, will help you provide an exceptional customer experience.

Little things like personalized messages in the app go a long way in making the customer feel valued and in increasing the customer's average lifespan.

Add essential items to the product

Add features to your product that keep customers from leaving.

For example, a personalized dashboard that the customer can build with their data to improve the overall efficiency of their business.

This kind of thing makes the customer dependent on your product because it makes their life more enjoyable and promotes long-term growth. This contributes to customer loyalty and increases their average lifespan.

Reassess your value proposition

To truly understand your loyal customers, you need to keep track of their growth. It would be helpful if you reassess your value proposition often to ensure that your product fits the changing needs of the customer. You can even consider bundling/ungrouping certain characteristics or changing your packaging and pricing. This involves some experimentation that can only be successful if you know your customers well and have data to back it up.

Listen to your customers - Gather useful information

Happy customers are loyal customers. It is extremely difficult to grow your business without knowing what your customers think of you. On the other hand, it is much easier to develop thanks to detailed and actionable feedback.

Understanding your customers allows you to prioritize the aspects of your business that fuel customer satisfaction and revenue growth, while reducing ineffective tactics.

It also provides real data on how likely your current customers are to recommend your product or service to their contacts.

You should definitely collect and store all the feedback you receive in one place and share it with all departments. In addition, have a team responsible for monitoring customer sentiment online (on social networks, your communication channels, review sites, etc.

Encourage customers to switch to annual billing

If you're selling a recurring product or service (for example, web hosting or SaaS), the total amount of time that customers continue to pay is one of the most important factors in affecting your CLV.

Customers who stay loyal to your product generate predictable revenue, while those who only pay for it for a month or two generate very little revenue, not even covering your customer acquisition cost (CAC).

If your customers stay for less than 10-12 months on average, an easy way to improve your CLV is to encourage them to switch to an annual billing cycle. This reduces churn by engaging your customers over a year of use, resulting in a higher average CLV and more time to justify the value of your product/service.

Conclusion of this article on CLV

Successful subscription businesses are obsessed with their CLV because it provides them with crucial information for customer success, product development, marketing or business strategies, and pricing strategy. With the tactics mentioned above, you'll be able to strengthen your CLV and keep your customers happy.

And when you keep your customers happy, your revenue increases. It's about finding the most effective loyalty strategy for your business.

To go further