Business owners and marketing experts tout the benefits of keeping existing customers happy. One of the most common explanations is that it is cheaper to sell to them again than acquire new ones.
Many online marketing techniques follow the same idea, such as pay-per-click remarketing services. In this strategy, the company designs the ads to target those who have already bought the product. The goals can vary from generating more sales from people who have been proven to have the capacity to pay or re-engage those who seem “dormant.” Either way, the goal is to recapture these customers.
Considering that the business spends money on marketing, are all customers worthy of the re-engagement? One of the ways to find out is to know their customer lifetime value (CLV).
What Is Customer Lifetime Value?
Customer lifetime value (CLV) predicts the net profit attributed to the entire future relationship with a customer. In other words, it is an estimate of how much money you will make from each customer from now until they stop making purchases.
The calculation includes all sources of income for this particular client. Both the new revenue and repeat purchases are taken into account. You can calculate the average per-customer profit over their whole engagement with your business or focus on their initial purchase to get started.
It depends on your business model and plans for monetizing through upselling or cross-selling in the future. Regardless of your strategy, this is important information that can really help shape your marketing strategy and inform your overall business strategy.
Why Is It Important?
Knowing exactly how much money a single customer brings in during their engagement with your brand helps inform different aspects of operations across departments:
- Having a good estimation of CLV will guide your pricing strategy and help you adjust it to meet revenue goals.
- If your brand is selling directly to consumers, the CLV metric can be used to inform retention efforts by helping identify customers that might be at high risk of churning or canceling their subscription.
- CLV is also a significant indicator for affiliate marketers and other businesses that monetize using referral programs. This allows them to verify if they are generating quality traffic and/or delivering value for their partners.
- It’s not just essential for calculating how much money you make from each customer either. You can use an accurate LTV calculation as a baseline to better forecast the growth rate of your business. Instead of looking at past sales performance, you can calculate your current revenue and compare it to CLV to reach a more realistic estimate of how much you should expect the business to grow.
The actual dollar amount per customer is only one part of it, though. The business is ultimately interested in understanding if the customers are making it enough money.
In some cases, the business generates high customer acquisition costs. Once the initial transaction is made, all future profits will offset this cost until it’s paid off. New customers, after the break-even point, begin generating profit for the business. It can also mean that marketing efforts are better put toward retaining existing customers than acquiring new ones.
However, some businesses are willing to take the high acquisition costs for a more stable cash flow later. One of the companies known for doing this is Netflix. Based on its business model, despite the competition it faces with Disney and Hulu, it still offers some of the lowest subscription rates since it helps increase its subscription base.
How to Calculate CLV
The best way to calculate your CLV is using the customer lifetime value formula. This takes into account all revenue channels that you have opened for each of your customers. Depending on how advanced your business model is and what data points are available, a few caveats can influence the accuracy of these calculations.
The simplest example will be this. Assume that in six months, one customer ends up spending $1,500 worth of purchases from your business. Then you have determined that the total acquisition cost is $500, which can already cover marketing and shipping, to name a few. The total CLV, therefore, is $1,000.
The calculation, though, can still get complicated. Usually, transactions can become more complex as the relationship grows. For instance, you can offer discounts or coupons, or the customer can initiate a few product returns. Then, you have different demographics or categories for your many customers.
CLV is a great tool for decision-making, especially when the budget is low. You can be more strategic in how you spend your limited resources.