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What is the customer lifetime value (CLV), and How can you calculate it?

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5th Oct, 2022
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What is the customer lifetime value (CLV), and How can you calculate it?

The complete worth to a business of a particular customer over the entire period of their business relationship is called Customer Lifetime Value (CLV). It is a key metric tracking the amount of business received throughout the relationship. Variations in products sold, their costs, the number of purchases, etc., make the customer lifetime value calculations a complicated task.

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CLV is a statistical measurement of the expected total income generated from a typical customer for the duration the customer remains a client to a business. When CLV is measured, it is the best option to consider the total average revenue generated by the customer and the average net profit. These provide very insightful data regarding the business interaction capabilities with clients and customers. Furthermore, it also helps you analyze whether you must reevaluate your marketing strategy. 

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Why does customer lifetime value matter to all businesses?

The process of evolution does not take place immediately. It is a slow process involving several small improvements and changes over a long time. Here are a bunch of reasons why CLV matters to any business:

  • Improvement requires an analysis of the metrics

When you break down the components of CLV and measure them, it becomes easy to study and analyze them, allowing you to find weaker areas and adopt strategies to improve them. Using different strategies in advertising, pricing, and pitching can help you drive sales and improve profits in no time. This simplistic method helps you save time, money, effort, and resources.

  • Changes in the course of customer acquisition costs

CLV is a statistical tool that helps you maximize profits from your customer. It gives you an insight into what the customer is trying to buy and how to maximize sales and steer the course of your business in the direction of target customers.

  • Enhanced forecasting capabilities

CLV helps you make future strategies and decisions on staffing, inventory, distribution of resources, production capacity, etc. Without CLV, it would be impossible to determine where and how you manage your resources without overspending or wasting them. CLV helps you forecast the future, thus keeping you well informed and giving you a chance to change and adapt to the erratic future.

Merits of understanding and using the CLV metric

As mentioned above, CLV helps you build a safety net while expanding your business. Here are all the advantages you can gain from CLV:

  • Increase, drive, and repeat sales

Customer lifetime values provide you an opportunity to build a loyal customer base. With this tool, you can track the average number of visits over time and use this data to form the perfect strategy to drive your sales. It shows you areas needing improvements to bring back the same customers to buy from you again, helping businesses in the long run.

  • Promoting higher value sales

CLV aids you in finding the perfect balance between short-term and long-term marketing goals. It helps you understand your financial returns while trying to expand it. CLV promotes decision-making in terms of choosing the right customers to maximize profits.

  • Better customer retention

Undoubtedly, customer lifetime value helps you address customer retention to increase their lifetime with your business, enabling you to maximize profits. The appropriate segmentation while tracking these details is vital as it helps you build trust with your clients, rewarding you further with loyalty. 

  • Elevation of profits

Higher the customer lifetime value, the greater the profits. By increasing the client’s journey with your business, your profits are elevated. It can encourage them to spend more money on your services while encouraging similar customers to buy from you.

Challenges of CLV

As simple as it may sound, there are some challenges that you might face with customer lifetime value. These include:

  • Arduous measurement

Measuring CLV could be tedious. You might require complex tracking systems to measure all the involved parameters. A quality tracking system might be challenging to procure, given the size of your business. An enterprise resource planning (ERP) software or a customer relationship management (CRM) system can simplify this task. These have automated dashboards and traceable KPIs, making it easy to calculate the CLV.

  • Misleading results and over expectations

CLV is a beneficial metric. However, it can also build a facade over specific customer segments and resources. Splitting the data by customer location and size might help you with this problem but not entirely, as you can never precisely determine your customer’s behavior.

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How to calculate customer lifetime value?

If your business already has an ERP or a CRM system, the mathematics behind calculating the CLV can be left to the system to manage. However, if done manually, you can use the formula below:

Customer Lifetime Value = (Customer Value x Average Customer Lifespan)

Where,

Customer value = Average Purchase Value x Average Number of Purchases

These inputs act as resources you can use to grow your business. As every business move impacts your CLV, it is vital to strategize appropriately at a given time. 

Models Used to Measure CLV

Two models are commonly used to determine the CLV. It is crucial to note that both of these models produce different results. The results, in turn, are dependent on the type of data- pre-existing or predicted data. 

1. Predictive Customer Lifetime Value

This model interprets the future buying behavior of both new and existing customers. It does this using either machine learning or regression. Using the predictive model aids you in finding your most valuable customers, the strategies and products that drive your sales, etc. This data greatly helps in customer retention.

2. Historical Customer Lifetime Value

This model uses pre-existing or past data to forecast the customer value without determining if the existing customer shall continue to have a relationship with your business or not. It is a model that makes use of an ideal condition and, as a result, poses many drawbacks without considering the environment’s uncertainty. 

Steps to measure CLV

Here are four significant steps to determine your CLV manually:

1. Determination of the average purchase value

The average sale value is generally considered over a while. It is constantly tracked and calculated for at least a month.

2. Determination of the average purchase frequency rate

When a customer purchases multiple times during the time under consideration, the frequency rate can be tracked and determined.

3. Determination of the customer’s lifetime

It is a crucial piece of data that brands must track to determine the CLV. Ensuring that customer satisfaction is at its peak is vital.

4. Calculation of customer lifetime value

As you have determined all the necessary parameters, you can calculate the CLV using the abovementioned formula.

How to increase the lifetime value of a customer?

As CLV largely depends on customer retention., it is vital for business expansion. Here are a few points you should keep in mind to improve your CLV:

  • Optimization of your customer onboarding

Keeping your customers updated about your brand and aim helps keep them around for a long time. Furthermore, optimization of customer onboarding enables you to build a framework for long-term relationships.

  • Elevate your average order value

Complimentary services from your end to customer service work as a bonus and help you increase your average order value. It assists in improving customer service to continue a successful business relationship.

  • Learn and listen

Customers have the best advice. Listening to and implementing their ideas is important to understand customer requirements. It helps in keeping them around for longer and improving customer satisfaction.

  • Establish long-lasting relationships

It solely depends on building trust with your customers. Offering them the best services while ensuring consistent engagement on different platforms helps you build long-term relationships with your clients, thereby increasing your CLV.

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Getting started on improving your CLV and expanding your business

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With a comprehensive syllabus and experienced professionals, upGrad can help you learn and understand CLV and how you can incorporate the knowledge to improve your business. 

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Profile

Karan Raturi

Blog Author
Karan Raturi is the General Manager of upGrad North America. He has also led various finance, strategy, and operations teams at Wayfair, Kurt Salmon, and IBM.
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Frequently Asked Questions (FAQs)

1Is it necessary to calculate CLV accurately?

It is essential to understand that CLV is not an accurate metric. It only provides an insight into what the future might hold. Accuracy of CLV is only necessary when it comes to planning, budgeting, allocating resources, and checking expenses.

2Why is CLV important?

CLV directly affects customer retention rates and acquisition costs. It also helps you understand and improve customer services and loyalty to enhance your profits.

3What does the negative value of CLV determine?

A negative customer lifetime value means it costs the business more to serve their customers than to make money while doing business with you.

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