Don’t spend another dollar on your digital marketing funnel until you learn how to calculate customer lifetime value. We’re serious. And, if you’re scratching your head wondering, “What the heck is customer lifetime value?” Do not pass “Go,” and do not collect $200.
Customer Lifetime Value, or CLV, is a key metric used to estimate the total revenue your business can expect from a single customer over the entire relationship duration.
Now, answer this question (this a chance to redeem yourself if you did not pass “Go,” did not collect $200, and went straight to jail above).
“How do we know how much to spend to acquire a new customer if we don’t know how much revenue they will generate with us?”
Exactly! We don’t know. That’s why determining the customer lifetime value is so important.
If we anticipate that a customer will generate $1,000 in revenue over the lifetime of the relationship, does it make sense to spend $200 on marketing to acquire them? Absolutely!
How about if the customer lifetime value is only $100?
Oops. If we spend $200 to acquire a customer who only spends $100 with our business, we’re in the red. Do not pass “Go”—you know the rest.
Although there are different ways and various tutorials on how to calculate customer lifetime value, here’s a straightforward, step-by-step guide:
Step 1: Calculate the Average Purchase Value
To find the average purchase value, divide the total revenue made over the past year by the number of purchases during that same timeframe.
Formula:
Average Purchase Value = Total Revenue / Number of Purchases
Example: To simplify the math, let’s say your business generated $100,000 from 200 purchases over the past year. The average purchase value is $500.
Step 2: Determine the Average Purchase Frequency Rate
This is the number of purchases divided by the number of unique customers within the past year.
Formula:
Average Purchase Frequency Rate = Number of Purchases / Number of Unique Customers
Example: With 200 purchases and 100 customers, the average purchase frequency rate is 2.
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Step 3: Calculate Customer Value
Customer Value combines the average purchase value with the purchase frequency.
Formula:
Customer Value = Average Purchase Value X Average Purchase Frequency Rate
Example: If the average purchase value is $500 and the frequency rate is 2, the customer value is $1,000.
Step 4: Find the Average Customer Lifespan
To determine this, calculate the average years a customer continues buying from your business.
Example: If the average customer lifespan is 3 years, use this figure in your customer lifetime value calculation.
Step 5: Calculate the Customer Lifetime Value
Now, combine the data.
Formula:
Customer Lifetime Value (CLV) = Customer Value X Average Customer Lifespan
Example: If the customer value over one year is $1,000 and the lifespan is 3 years, the CLV would be $3,000.
Why Customer Lifetime Value Matters?
Understanding CLV is essential for growing a profitable business (check out five effective growth strategies for small businesses here.) Knowing and tracking customer lifetime value enables us to make smarter spending decisions in our digital marketing and client acquisition efforts.
Want more information on calculating customer lifetime value for your business? Schedule a no-cost exploratory call today.
