How to Calculate Customer Lifetime Value
Calculating Customer Lifetime Value (CLV) is one key way to measure your growth, as it takes both acquisition and retention into account. Not all customers are created equal. This article will show you how to calculate CLV and apply it to your acquisition marketing for better long-term results.
Just like the gambling world’s high rollers, there will always be bigger spenders in a group of customers. Casinos provide private rooms and lavish perks for these “whales,” which are tactics engineered to keep them betting big. Similarly, providing your most valuable customers with a highly personalized and rewarding experience keeps them spending.
A Crash Course in CLV
The best way to identify your own “whales” is by measuring CLV. A quick refresher: CLV measures the potential net value of a customer during the time they’re engaged and spending with your company. Since we can’t predict exactly how long each relationship will last, we calculate CLV as a periodic value based on a given estimate of time.
CLV helps you see the big picture and the results may surprise you. Sometimes, your company’s high rollers are hiding in plain sight.
For example: say Customer A has an average order value (AOV) of $100, but only makes purchases twice per year. On the other hand, Customer B spends in smaller average increments of $45, but makes purchases every other month. We would calculate Customer A’s 12-month lifetime value as $200; Customer B, despite having smaller transaction amounts, has a 12-month lifetime value of $270 – and is, therefore, the more valuable customer.
If your company only looks at AOV or single transactions to identify big spenders, you risk letting Customer B fall through the cracks. CLV helps you identify these valuable repeat customers by evaluating profit over time instead of just one-off purchases.
Factoring CLV into Acquisition
CLV is often emphasized in retention marketing, and for good reason: effective customer retention lengthens the lifetime of each customer, thereby increasing overall lifetime value.
However, CLV plays an important role in acquisition, too. The goal of acquisition is to acquire as many customers as possible, ideally at a minimal cost, or Cost Per Acquisition (CPA). The logical step, then, is to go with the lowest Cost Per Acquisition (CPA) when selecting acquisition channels, but this actually isn’t the best way to prioritize your spending.
Consider this: if spending $1000 on Facebook ads results in 100 acquisitions, your CPA is $10; in contrast, 75 customers from $1000 on Google Adwords equals a CPA of $13.33. Traditional logic says to go with Facebook – 25% more customers for the same spend.
Again, CLV helps you think big picture. If customers brought in by Facebook have a lower CLV than customers via Adwords, the additional spend will be worth it.
Rather than looking at the lowest CPA, focus instead on the maximum value. Just as you shouldn’t judge a customer’s value by AOV or transaction amounts alone, don’t judge the acquisition channel purely by upfront costs. CLV helps identify which channels bring in the most valuable customers, which will be more profitable in the long run.
To savvy companies, customer acquisition and retention go hand in hand. Acquiring the right type of customers is the first step; then comes the task of providing the right incentives and messaging to keep them engaged. A long-term strategy is key for success, and that means thinking about retention even during acquisition.
ReSci is a team of marketers and data scientists on a mission to democratize AI. We make powerful recommendations and predictions accessible to brands.
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