Customer Lifetime Value (CLTV) - What is CLTV?
Customer Lifetime Value (CLV / CLTV) is a metric that allows a business to see how much revenue a customer might bring in over time.
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The customer lifetime value metric allows a business to reasonably predict how much revenue a customer will contribute over the average estimated length of time that they’ll continue to be a customer.
It’s necessary for the business to determine the average ‘lifespan’ of a customer in order to make the CLTV calculation. The customer lifespan can say a lot about a business and naturally, a longer lifespan is generally preferable.
It’s also important to note that unlike Customer Profitability (CP), CLTV attempts to provide an indication of the future revenue of a customer, not the past profits generated by the customer.
Determining how much a customer will provide in revenue to a business over the course of their time as an active customer is, understandably, a bit complicated. There are several different calculations that must be worked out before being entered into a formula for estimating CLTV. These include:
This can be tricky for businesses just starting out. For more established businesses, taking into account the average number of years their customers continue to be active and dividing it by the total number of customers for those years will provide a good indication of an average lifespan.
How often does the customer make a purchase? If the business offers products purchased frequently (a coffee shop, for example), the frequency is likely higher than an online monthly subscription-based service. The number of visits/purchases is the frequency.
In order to be able to understand how much a customer will spend over time, it’s crucial to find the average of what they spend on a regular purchase. This can be determined by dividing the total amount a customer spends over a certain time by the number of purchases within that time.
This element determines how much on average a customer will spend in a given period as an active customer.
For example, if a business sees customers regularly, such as every week or every day, they could use the time period and multiply this by the amount spent each time (the average purchase value determined in the step above).
With the above information ready, there’s a fairly straightforward equation that allows for a quick calculation of CLTV:
CLTV = Average customer value / Average customer lifespan
The customer value determined in the 4th step above is divided by the average customer lifespan in order to calculate what the Customer Lifetime Value will be for that period.
The CLTV metric provides important insight into how well a business is retaining customers. With the exception of some industries, most businesses prefer to have repeat customers that will continue to return again and again.
It also provides an idea of how well a business will profit from customer purchases. Retaining customers is significantly cheaper for a business than gaining new ones. This means that being able to predict how profitable an existing customer will be is a big step towards understanding a company’s financial health.
Higher CLTVs translate to higher profits at less cost for a business. Many businesses will be looking for ways to improve their CLTV. This involves appealing to and being reliable to existing customers, so the work shouldn’t stop once a customer has been gained.
Traditional methods have shown to work well - this includes targeting certain customer segments to promote different products, providing regular newsletters with useful information for customers, creating new products that relate to existing successful ones or providing special offers for loyal customers.