When your business makes a sale to a new customer, is that sale the end of the customer journey, or the start of a longer-term relationship?
Customer lifetime value is one of the business metrics that shows how much customers spend with a business over time, rather than in a single transaction. In this article, we will explain how to calculate your customers’ lifetime value, and how understanding this principle can help you make better business decisions.
What is Customer Lifetime Value?
Customer lifetime value, or CLV, refers to the amount that a customer spends with a business over the entire period that they are a customer.
Perhaps a new customer would spend an average of £1,000 on their first order with your company. However, if you could predict that this customer would potentially spend £10,000 with your company over the next five years, that would give you an insight into how valuable that customer is, as well as provide you with insights to support better forecasting and understand the time value of money.
CLV can also be referred to as lifetime value or LTV.
Why is CLV important?
For Daniella Genas, Founder and Director of the consulting group Be the Boss International, CLV can be useful for quantifying just how successful your business is at customer retention.
“Customer lifetime value is a really important metric because it tells you how well you are serving your customers,” she says.
“A lot of businesses focus on constant acquisition, but lifetime value helps you to understand how many customers you are retaining.”
Businesses that can keep customers spending over multiple transactions are more profitable because it costs less to sell to an existing customer than to win a new customer, Genas adds. This is because you don’t need to invest as heavily in marketing or advertising.
It can help identify problems
A business that has an average order value of £1,000 and an average CLV of £1,500 would suggest that the majority of customers make just one purchase from the business and then move on. “In most cases, you want customers to come back and buy from you again, whether that’s buying a complementary product, or buying new products from you,” says Genas.
This can be problematic for a business because it impacts your bottom line. If you’re constantly relying on new customers, you have to pay for the cost of acquisition each time which impacts profit margins. Ideally, CLV should always be higher than the cost of acquiring new customers. Calculating CLV will provide you with insight into this.
It measures customer retention
“Your existing customers are likely to make purchasing decisions more quickly, spend more per transaction and potentially pay you quicker if they are already used to buying from you,” she says.
Customer retention is a huge priority for London-based travel agency The Honeymoon and Holiday Fixer. Founder Britt-Marie Monks has implemented training to ensure the company’s agents regularly reach out to customers to check their travel plans or offer additional services such as car hire or lounge access after they have booked a holiday. “We try to support customers with smaller bookings like a single flight, not just big destination trips,” says Monks. “By acting more like a lifestyle concierge than a travel agent, we can build long-term relationships with customers.”
It can support your marketing strategy
Customer lifetime value is also an important way to understand how to market your business. This metric should be considered when answering questions such as:
- How much should I invest to retain customers?
- How much time should we invest in gaining new customers?
- Is our marketing successful in attracting repeat business?
CLV, used together with customer analytics, can help business owners identify their most valuable customers and what marketing they’re most likely to respond to. “This means you can develop discounts or offers that will attract those sorts of customers specifically, rather than offering blanket discounts to all customers, which can become really expensive for an SME,” says Genas.
Once you've used CLV to identify your most valuable customers, and you're ready to target them with a clear online marketing strategy, make your budget go further with the American Express® Business Gold Card¹, which is accepted by Google, Hootsuite, Buffer, and many other major marketing tools. Earn 1 Membership Rewards® point for every £1 you spend, which can be redeemed as a statement credit or used to reinvest in your business².
How to calculate the lifetime value of a customer
The lifetime value of a customer illustrates how much revenue or profit a customer might be expected to bring into your business over the length of that relationship. To calculate CLV, businesses need to multiply the average customer value by the average customer lifespan.
Customer lifetime value formula
The formula to calculate CLV is shown below:
CLV = Customer Value x Customer lifespan
CLV step 1:
To calculate customer value, divide revenue over a specific period (such as a year) by the number of customers to provide an average value per customer. For example, if a carpet shop has annual revenue of £2 million and 5,000 customers, the average customer value would be £400 (total revenue divided by the total number of customers).
CLV step 2:
To calculate the customer lifespan, measure the average number of days from first orders to last orders across your customer base. This figure will usually be expressed as years.
If the carpet shop found that there was an average of 2,500 days between the first and last orders of its customers, this would translate to a customer lifespan of 6.8 years.
CLV step 3:
Next, to calculate CLV, multiply the two results from Step 1 and Step 2 together. Using the carpet shop example, we can see that the carpet shop has a customer lifetime value of £2,720.
CLV = Customer Value (400) x Customer lifespan (6.8) = £2,720
How to increase your customer lifetime value
Over the past five years, the CLV at The Honeymoon and Holiday Fixer has increased by more than 20%. That’s because Monks trains her staff to focus on keeping customers coming back for more, believing that it’s easier to drive growth and profits by building long-term relationships with existing customers.
“Focusing on customer lifetime value and growing that number means we’re always looking for ways to connect with customers and build repeat business while increasing the average order value,” says Monks. “It allows us to minimise marketing spend and keep the cost per acquisition (CPA) low.”
There are a number of strategies that can increase your customer lifetime value as a business, says Genas. Perhaps the most important is focusing on creating the best possible customer experience, she says. Doing so means customers may be more likely to opt-in to hearing from you again in the future, helping you build out a list of email subscribers.
Business leaders must also make asking for feedback routine, adds Genas.
“Feedback is the number one way to improve the customer experience and therefore increase your customer lifetime value,” she says. “Some SMEs are afraid of negative feedback and think it’s a problem. In reality, it’s the best feedback to have, because if all my customers are providing positive feedback, it doesn’t give me any way to improve my product.”
1. The maximum payment period on purchases is 54 calendar days and is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date. If you'd prefer a Card with no annual fee, rewards or other features, an alternative option is available – the Business Basic Card.
2. Membership Rewards points are earned on every full £1 spent and charged, per transaction. Terms and conditions apply.
