What is Customer Lifetime Value and How Do You Improve It?

 

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Do you get lost trying to keep up with industry standards on what metrics to track and what not to track? 

Or perhaps you feel you’re tracking the wrong metric altogether and it’s having little to no impact on your MRR or ARR?  

Well, you’re not alone —and yeah it can be quite exhausting trying to optimize every single metric out there. 

One minute you’re measuring your customer acquisition cost, —and in another, you’re keeping track of your churn rate.

This begs the question, will it ever stop?

No, I don’t think it will. 

However, wasting your time on pointless iterations that don’t move the needle should. 

And for you to do this, you need to focus on what drives sales to your business, —and those are your customers. 

An increase in ARR, or MRR, would never come from bots, it will come from people. And people only buy products or services that provide value to them. 

Now, taking your customers as the most important part of your business changes the view of your marketing strategy.

You go from selling to mere buyers to engaging a customer base of dedicated and loyal fans. All of which are made possible when customers feel valued.

To understand the value every customer brings to your business, you need to be tracking a single metric called —Customer Lifetime Value.

TL: DR —Take a Leap 

What is Customer Lifetime Value?

How to calculate your Customer Lifetime period Value

     Average Order Value (AOV)

          Why your AOV Matters

     Purchase Frequency (PF)

          Why your PF matters

     Average Customer Lifetime (ACL)

     Common mistake made in calculating churn rate

How Your AOV, PF, and ACL produces your CLTV

Why is CLTV important to your business?

How to Improve Your Customer Lifetime Value

          Improve your Customer Onboarding Experience

          Implement a Loyalty Program

          Build Relationships Through Active Communications with Customers

In conclusion,

What is Customer Lifetime Value? 

Customer Lifetime Value (CLTV) or (CLV) simply refers to the value a customer brings to your business during their lifetime of using your product or service. 

This metric considers an estimated value of the customers’ revenue during the “paid use” of a product or service and compares it with the cost of acquiring that customer during the customers’ lifespan. 

A good CTLV follows a model where the cost of customer acquisition is relatively low.

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For early and growth-stage companies, measuring your CLTV is an important metric that determines the success of that company.

Why you may ask? 

For starters, the goal behind measuring a customers’ value to a business is to boost customer retention. 

In a study by Harvard Business Review, they found that acquiring a new customer is anywhere from 5 to 25 times more expensive than retaining a new one.

It goes even further in the research done by Frederick Reichheld of Bain & Company, which he called “Prescription for Cutting Costs”. In this research, he discovered that even across a wide range of businesses with different models, each additional year a customer stays generates an increase in profits for such a company.

An increase in the profits and revenue of companies like these is a result of the proper measurement of their CLTV and utilizing the metrics in keeping valuable customers longer. 

But what are these metrics, and how do you calculate them? 

How to calculate your Customer Lifetime Value

The concept of calculating your customer lifetime value is highly dependent on the business model you’re running. 

In a practical sense, a business model based on a one-time purchase can’t measure their CLTV like a subscription-based business model. 

However, a unified process for measuring your CLTV should be based on how much revenue each customer adds to the business. 

Using each customer’s lifetime additional revenue to the business allows you to take into account your CAC (Cost of Customer Acquisition). 

In simpler terms, you can calculate your CLTV by multiplying your customers’ average order value by their purchase frequency, and average lifetime. 

The formula for Calculating Customer Lifetime Value

 

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This is the most basic formula you need to get going in calculating your CLTV —but let’s take a pause and discuss the basics of each metric and how they contribute to producing an estimate of a customers’ LTV.

Average Order Value (AOV)

The average order value (AOV) or sometimes called “Average Purchase Value” (APV) is the average amount spent each time a customer places an order for a product or service.  

In calculating your AOV, you need to divide your revenue by the total number of orders placed. 

 

Practical example: 

Let’s say you run a done-for-you graphic design service like Canva, and in the month of June, you had 200 orders come in, with total revenue of $20,000 for the month. 

Your AOV will be $20,000 (revenue) divided by 200 (number of orders) = $100 

This puts your AOV for the month at $100

 Why your AOV Matters

As a business, your primary goal is to get as many customers as possible but without breaking your bank in acquiring them. 

To achieve this, your AOV metrics are important to help validate all your marketing efforts. With this validation, you’re able to ascertain the value each customer brings to your business at each level of the market funnel. 

A rule of thumb is to measure your AOV on a regular periodic basis (e.g. monthly) and compare results to know where you need to direct your marketing efforts in achieving the best value for your business. 

Purchase Frequency (PF)

This refers to the average number of purchases made by each customer with a single seller within a period of time. 

Or you can define it as measuring how often a customer purchases a product or service from a business over a period of time. 

The PF takes into account the number of orders in correspondence with the number of unique customers within a period —usually in a year. 

 

 

In utilizing the PF formula, you should consider the time frame you intend on calculating. 

Typically, one year is recommended for getting the best PF results as it gives you time to understand customers buying behaviors all across different periods of the year. 

Nonetheless, you can still calculate your PF quarterly using the same formula.

Furthermore, it’s required you include “unique customers” when you calculate your PF to avoid measuring duplicate purchases. 

 

Practical example:

Take for instance from January of 2020 to December 2020, you had 580 unique purchases and a total of 300 customers. 

Your purchase frequency will be 580 (the number of purchases) divided by 300 (number of customers) = 1.9. 

This puts your prior year PF at 1.9. 

 

Why your PF matters

The fundamental ground on which PF is built is to utilize customer behavior as a benchmark in influencing repeat purchases for a business. 

These behaviors result in tailored marketing campaigns for such customers for repeat purchases to happen. 

A classic example of such a campaign is a win-back email campaign to customers who haven’t purchased in a while.

With campaigns like these, the chances of repeat purchases become higher as you have a 60-70% probability of making a sale from an already existing customer compared to a 5-20% on a new one.

 

Average Customer Lifetime (ACL)

Average Customer Lifetime refers to the average number of years that a customer continues purchasing a business’s products or services.

 

In measuring the ACL of your business, you’re taking out the idea of the purchase itself but rather the value of a customer to your business over a period of time.  

This, in turn, gives you a proper understanding of how customer relationships have an impact on customer acquisition. 

With this, you can maximize customer relationships by implementing the ACL formula effectively all-round. 

However, your use of the above formula for your ACL will require you to wait for a long time. In a Lifetime Value case study by Kissmetrics on Starbucks, the average customer lifespan is estimated at 20 years. 

Although Kissmetrics did not accurately give a breakdown of how they got their results, averaging the numbers of times a single customer visited Starbucks all together puts the estimate at 20 years. 

But we can’t all be Starbucks and wait 20 years, so here’s another way. 

R+emen Okoruwa, Product Manager at Hubspot, derived a better way for measuring your ACL especially if you are in a subscription or eCommerce business. 

To find your ACL, you need to divide 1 by your churn rate.

 

 

 

When you’re running this type of business model, there’s a need to track your churn rate in relation to arriving at your ACL. 

A simple way to calculate your churn rate according to Remen is to track how many customers purchased in two sequential periods and divide that by the total number of customers who bought in the first period

Comparing two periods can be measured monthly, annually, or quarterly preferably —it depends on what you want to achieve.

To calculate your annual churn rate, for example, you can use this formula: 

 

Practical example: 

Take for instance, you run an eCommerce website where you sell male shoes. Last year you had 487 customers. 

This year you have a total number of 183 customers who bought last year and this year. 

Here’s how you’ll calculate your ACL. 

Back to our root formula, 

 

Your churn rate is 0.6%

Now that you have your churn rate, calculating your ACL is straightforward. 

Simply use the ACL formula and divide 1 by 0.6% to get your ACL. 

In this case, it’ll be: 

 

 

 

Which gives your Average Customer Lifetime of 1.6 years.

Common mistake made in calculating churn rate

In calculating your churn rate, it can be quite confusing at first because you might think your total number of customers this year should exceed that of last year. 

Well, it can’t, and here’s why. 

First, the formula takes into account the dividend (total number of customers who bought last year and this year). 

This means, you only include a customer in the dividend IF he or she purchased in both years —otherwise you don’t count them. 

Second, the divisor (total number of customers who bought last year). 

This means you’re taking account of all your customers who purchased last year —quite simple. 

As a result of this, the dividend will always be smaller than or equal to the divisor when calculating your churn rate.

How Your AOV, PF, and ACL produces your CLTV

At the heart of a business’s sustainability and profitability lies the proper use of CLTV in all areas of customer-product interaction. 

Both organic and paid forms of customer acquisition are only as good as they get based on the CLTV. On the other hand, utilizing metrics that make up for it from the ground up is a big game-changer. 

Having all these metrics together provides you with the knowledge of understanding your customer base better than before. 

As a result, you get a business that is “product-market fit”. 

 

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This goes further to build you two strong pillars in the industry, namely: brand loyalty, and returning customers. 

  • Your AOV allows you to know the amount spent each time a customer places an order for your product or service.  
  • Your PF gives you an estimate of how much a customer is loyal to you based on how frequently they purchase from you. 
  • Your ACL gives you an overview of how long your customers will keep returning. 

All these put together, are what produce the estimated value a customer brings to a business over the time spent purchasing your product or services—which is the Customer Lifetime Value.

Nonetheless, the metrics covered here extend to a length on how to calculate your CLTV effectively. It however still begs the question;

Why is CLTV important to your business? 

It needs no convincing to you as a marketer and business owner on the importance of revenue for your business’s sustainability and financial stability. 

Now, getting revenue for any business is dependent on the business-customer relationship you’ve established beforehand. 

Taking time to measure your CTLV gives you an idea of how best to position your product for these customers.

Which in turn gives you an overview of the 5 core parts of a business. 

  • Retention
  • Conflict
  • Prospects
  • Turnover
  • Branding

 

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With this, you can personalize all their experiences based on buying habits.

The ROI of all these, lets you have a dedicated community of customers who have adopted your product or services to solve their problems.

Hence a win-win for you and your customers. 

But it doesn’t stop there, rather;

The core basis of CLTV is for you to get an increase in revenue with less acquisition cost

Contrary to what most marketers and business owners believe, spending beyond the recommended budget on acquiring customers is a big loss for a business. 

A rule of thumb for your CLTV to CAC ratio is 3:1

 

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And never beyond that!

Your CLTV comes as a way to pinpoint the important buying patterns and behaviors of your customers to eliminate unnecessary marketing spend. 

With that, you’re able to optimize your marketing budget on customers who already trust you. Even better, a study by Hoovers further proves that a 5% increase in customer retention can boost profitability by 75%.

In an actual sense, your goal is to reduce the spending on acquiring new customers, and instead focus on retaining existing ones.

How to Improve Your Customer Lifetime Value

So far, you’ve covered what CLTV is, how to calculate it, and its importance. The next step is understanding how you can improve your CLTV to retain more of your customers. 

     1. Improve your Customer Onboarding Experience

First impression matters and onboarding customers for the first time is a one-off chance. If you do it well, they stay, —and if you do it badly, they leave. 

In Wyzowl’s industry report on businesses onboarding experiences, they discovered that — 

Nearly two-thirds (63%) of customers say that onboarding – the level of support they’re likely to receive post-sale – is an important consideration in whether they make the decision in the first place.

The report even goes further to show that —

“86% of people say they’d be more likely to stay loyal to a business that invests in onboarding content that welcomes and educates them after they’ve bought.”

With stats like these, churn rates continue to go higher after the first onboarding experience. To avoid situations like this, you need to make your onboarding experience educational rather than sales-y. 

An intuitive and detailed breakdown of how your product or services work is a huge game-changer especially when you move potential customers to big-time fans.

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It tells the customer that you’re dedicated to solving their problems or help them get their desired results.

 

 

 

     1. Implement a Loyalty Program

Improving the value a customer brings to your business is based on how frequently they purchase from you. 

A perfect way to increase this is by implementing a loyalty program that focuses on each customer’s personal experiences and buying behavior. 

Why loyalty programs, and how is it important? 

A quick view on the impact of loyalty programs shows that 49% of Gen Z would pay to upgrade their loyalty program membership. This even accrues to your revenue as 57% of consumers spend more on brands which they are loyal to.

Evernote for example make the best use of their loyalty programs in targeting students.

They slashed 50% of their premium subscriptions for eligible students, which in turn incentivizes their target market to choose the premium plans compared to their other plans.

Customers love having a sense of reward for buying a product or service, a loyalty program is a good way of retaining them for a longer period, and capitalize on that relationship. 

 

 

     3. Build Relationships Through Active Communications Customers

The most successful companies in history never did anything out of the ordinary to stand out. Instead, all they did was create a good line of communication between the company and their customers. 

It’s no wonder that 89% of customers are more likely to make another purchase after a good customer service experience. 

For a moment imagine how much 89% of your customers will return to you simply because they’re able to communicate with your business. 

And no, I’m not talking of automatic responses, —rather, an active human correspondent that gives the company life. 

The ROI of good customer service can not be quantified as it keeps going on as long as the company is still in business. 

It can go as far as a single customer bringing in 9 others through referrals.

 

Referrals like these are a bi-product of good customer service, giving you better ROI than any other marketing tactic you have. 

It goes further and reflects on your landing page, blog posts, newsletters, and overall business areas just how much you communicate with your customers.

In conclusion, 

Keeping track of CLTV metrics spreads its effect far and wide in all areas of your business. With it, you can identify your most profitable customers and utilize the metrics in refining your marketing approach. 

From there, you get a sense of what drives your customers and how you can improve on delivering even better results for them along the way. 

All of these deliver back to your bottom line with a noticeable impact on your ARR at the end of the day. It’s a worthy investment that always pays off any time of the day —and in any business.

The best way to drive good conversions for your business is by utilizing the important metrics. However, getting those metrics shouldn’t take you days when you can get it in minutes. 

With TrueRev, you can skip the hassle of manual computing errors, instead get better spreadsheet management, cash flow management, and metric tracking, invoice automation, on-time report delivery, and a whole lot more. 

The fun part, you can try TrueRev for free —no credit card required. 

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