Customer Lifetime Value (CLV): How to Calculate and Increase It

Customer lifetime value (CLTV) is one of the top business metrics for measuring how much money customers bring to the company throughout their time as paying customers. If you want your company to attract and retain highly valuable customers, you must know what your customer lifetime value is and how to calculate it.

Despite its obvious importance, many companies ignorantly ignore this key metric or understate its importance. Sales teams are preoccupied with looking for effective ways to attract new customers, reduce their customer acquisition costs (CAC), and improve customer satisfaction levels. They pay very little attention to how much each new customer is worth.

Understanding your customer lifetime value (CLV) makes it easy for you to predict the revenue a new customer brings to your company throughout their relationship with you. It helps you better justify your sales and marketing budgets.

In this article, you will learn the meaning of customer lifetime value (CLV), the reasons why your business needs to calculate CLV, how to calculate customer lifetime value with examples, and how to increase your customer lifetime value.

Let’s get started.

What is Customer Lifetime Value (CLV)?

Customer lifetime value refers to the monetary value that a customer generates for a company based on the present value of the projected future spend from the customer relationship. It is the gross profit that a business realistically expects to generate from a single customer on the strength of their customer-business relationship.

The key metric encourages companies to focus on the long-term health of their customer relationships and not on their quarterly profits.

Customer lifetime value (CLV or CLTV) is also referred to as lifetime customer value (CLCV) or lifetime value (LTV). It helps businesses predict future revenue and measure long-term business success.

Since it involves some level of prediction, it can vary in terms of accuracy and sophistication, ranging from simple to the use of complex analytics techniques. The key metric gives you an idea of how much to invest in order to retain a customer.

Businesses use customer lifetime value to spot customer segments that generate huge gross profit. In theory, the longer a customer continues to spend on your product or service, the greater their customer lifetime value becomes.

Customer support uses this key metric to increase customer loyalty and reduce churn. Having responsive customer support representatives available to solve the problems of your customers and offer helpful recommendations is critical to keeping customers for a long period.

CLV starts from the moment a new customer makes his or her first purchase and ends when they make their last purchase and stop doing business with the company,

Customer lifetime value needs to be measured at regular intervals. Customers with high customer lifetime value are repeat customers of your brand, while those with low customer lifetime value are likely passive customers who make a one-time purchase.

Why Your Business Needs to Calculate CLV

Here are some of the essential reasons why your business needs to calculate its customer lifetime value (CLV) at regular intervals.

1. To Boost Revenue

Calculating your customer lifetime value is essential for businesses, particularly because of its direct influence on your revenue.

CLV helps you identify your highest profit customers. When you know these customers, it is easier to create loyalty programs to keep them as paying customers in the long term. It also helps you spot marketing channels that attract more of these highly profitable customers.

Businesses can also use CLV to gauge whether their business operations are improving or declining. It also helps businesses know if their business improvement measures lead to positive growth or not.

Since it deals with customers who the business relies on to be successful, calculating the CLV can uncover whether your relationship with customers is strong or not.

2. Boost Customer Loyalty and Retention

Calculating your customer lifetime value is essential to optimizing it. When a company consistently provides value to its customers in the form of responsive and professional customer support, products, and loyalty programs and incentives, it increases customer loyalty and retention.

Having excellent customer support, quality products or services, and loyalty products gives your business more loyal customers which in turn increases your customer lifetime value. With more loyal customers, your company’s churn rate reduces. Satisfied customers will result in more positive reviews, referrals, and sales.

3. Help Target Your Ideal Customers

Customer lifetime value arms you with the knowledge of how much money a customer spends on your business over a period. With this knowledge, you can develop customer acquisition strategies that target your ideal customers that spend the most on your products or services.

CLV also helps businesses to improve their marketing strategies and aim their marketing campaigns on a more ideal target audience.

4. Improve Customer Retention

The cost of acquiring a new customer is usually more expensive than the cost of retaining an existing customer. Harvard Business Review found out that businesses can spend between 5 to 25 times more on gaining a new customer than retaining an existing customer.

CLV helps you identify the most valuable customers that purchase the most of your products and services. It encourages you to improve customer retention which in turn naturally lowers your customer acquisition costs.

5. Shows How Much You Should Spend on Customer Acquisition

Customer lifetime value helps businesses know how much they should spend on customer acquisitions for the business to be profitable.

Your customer acquisition costs may be equal to or more than the amount made on a customer’s first purchase. To generate a profit, you have to retain the customer in the long run.

How to Calculate Customer Lifetime Value (with Examples)

Companies use two customer lifetime value models to measure their customer lifetime value. They are the historical customer lifetime value and predictive customer lifetime value.

Historical Customer Lifetime Value

The historical customer lifetime value model refers to the use of past data to predict the value of a customer without considering whether or not the existing customer will continue to maintain a relationship with the company.

With this model, the average order value (AOV) determines the value of customers. It is extremely useful if the majority of customers only transact with your business over a certain timeframe.

The problem with the historical customer lifetime value is that most customer journeys are not identical. Active customers who are considered valuable may become inactive and ruin your data. Also, inactive customers which it overlooks may begin to buy from you again.

The historical customer lifetime value model can not be used for predictions. It is only relevant if your customers have similar preferences and maintain a relationship with your company for the same period of time.

You can calculate your customer lifetime value by using the historical CLV value model by determining the average revenue per user (ARPU).

The formula for calculating average revenue per user (ARPU) is:

ARPU = TR / CQ

TR – Total revenue for a chosen period

CQ – Number of customers for a chosen period

Example

Let’s suppose 20 customers brought $1,000 in profit over a three-month period for a fertilizer company.

ARPU = TR / CQ

ARPU (3 months) = $1000 / 20

ARPU (3 months) = $50

Now, let’s check the CLV these customers bring to the company in a year.

ARPU (12 months) = ARPU (3 months) × 4

ARPU (12 months) = $50 × 4

ARPU (12 months) = $200

The historical CLV equals the average revenue per year (for one year) per customer is $200.

Predictive Customer Lifetime Value

The predictive customer lifetime value model shows a customer’s transactional behavior and uses it to predict future buying patterns. It is a more accurate model than the historical customer lifetime value model because it uses algorithms that can predict the total value of a customer to a business.

This model helps you more accurately identify who your most valuable customers are than the historical customer lifetime value model. It also shows you what product or service generates the most sales and how you can improve customer loyalty and retention.

There are many ways to calculate predictive customer lifetime value. The most complicated but accurate method for calculating customer lifetime value is:

CLV = T x AOV x AGM x ALT / Number of clients for the period

T = Average number of transactions per month

AOV = Average order value

AGM = Average gross margin

ALT = Average customer lifespan in months

Every variable in the customer lifetime value formula has a formula of its own. Before breaking down the customer lifetime value formula to show the formulas needed to calculate its independent variables, you first have to understand the customer lifetime value models.

Customer Lifetime Value Formulas

Average Number of Transactions (T)

You can calculate the average number of transactions by dividing the company’s total transactions by the period the transactions were made.

T = Total Transactions / Period

Average Order Value (AOV)

You can calculate the average order value by dividing the company’s total revenue in a period by the number of orders made in that same period (usually a year).

Average Order Value = Total Revenue / Number of Orders

Average Gross Margin (AGM)

You can calculate the average gross margin by adding the gross margin of different months under consideration and dividing it by the number of months.

The formula for determining the gross margin percentage per month is:

Gross Margin % = (TR – CS / TR) x 100

TR = Total Revenue

CS = Cost of Sales

The formula for average gross margin (AGM) is:

AGM = Total Gross Margin / Number of Months

Average Customer Lifespan in Months (ALT)

You can calculate the average customer lifespan in months by averaging the number of years a customer continues purchasing from your company.

ALT = 1 / Churn Rate %

The formula for measuring churn rate is:

Churn Rate = (CB – CE / CB) x 100

CB = Customer at the beginning of a month

CE = Customers at the end of the month

Calculation of CLV: Example 1

A coffee company recorded 240 transactions in 6 months. It generated $100,000 from 200 orders with its cost of sales at $50,000. The coffee company had 200 customers at the beginning of the period and had 180 customers at the end of the period. What is its customer lifetime value?

The formula for calculating customer lifetime value is:

CLV = T x AOV x AGM x ALT / Number of clients for the period

T = Average number of transactions per month

AOV = Average order value

AGM = Average gross margin

ALT = Average customer lifespan in months

First, you have to find the average number of transactions (T).

T = Total Transactions / Period

T = 240 / 6

T = 40

Second, you have to find the average order value (AOV).

Average Order Value = Total Revenue / Number of Orders

Average Order Value = $100,000 / 200

Average Order Value = $500

Third, you calculate the average gross margin (AGM).

Gross Margin % = (TR – CS / TR) x 100

TR = Total Revenue

CS = Cost of Sales

Gross Margin % = ($100,000 – $50,000 / $100,000) x 100

Gross Margin % = ($50,000 / $100,000) x 100

Gross Margin % = 0.5 x 100

Gross Margin % = 50%

The formula for average gross margin (AGM) is:

AGM = Total Gross Margin / Number of Months

Suppose the total gross margin is 240% for 6 months.

AGM = 240 / 6

AGM = 40%

Four, you calculate the average customer lifespan in months (ALT).

ALT = 1 / Churn Rate %

The formula for measuring churn rate is:

Churn Rate = (CB – CE / CB) x 100

CB = Customer at the beginning of a month

CE = Customers at the end of the month

Churn Rate = (200 – 180 / 200) x 100

Churn Rate = (20 / 200) x 100

Churn Rate = 10%

ALT = 1 / Churn Rate %

ALT = 1 / 0.1

ALT = 10 months

Now that you have all the variables you need (T = 40, AOV = $500, AGM = 40%, and ALT = 10 months), the final step is to calculate the customer lifetime value for the coffee company.

CLV = T x AOV x AGM x ALT / Number of clients for the period

The number of clients for the period is the total number of existing clients at the end of the month which is 180.

CLV = 40 x 500 x 40% x 10 / 180

CLV = $444.44

The predicted customer lifetime value is $444.44

Calculation of CLV: Example 2

The average sales in a bouquet store are $80 and, on average, a customer shops five times every two years, with its profit margin at 20%. What is its customer lifetime value?

Customer Lifetime Value = Lifetime Value × Profit Margin, where Lifetime Value = Average Value of Sale × Number of Transactions × Retention Time Period

OR

Customer Lifetime Value = Average Value of Sale × Number of Transactions × Retention Time Period × Profit Margin

Customer Lifetime Value = $80 x 5 x 2 x 20%

Customer Lifetime Value = $800 x 20%

Customer Lifetime Value = $160

The customer lifetime value of the bouquet store is $160.

How to Increase Your Customer Lifetime Value

Companies are always on the lookout for better ways to influence their customer experience positively. An increase in customer experience and satisfaction will no doubt increase customer lifetime value.

Some companies have the marketing strategies and financial defense to handle competitor disruption effectively without seeing a huge churn rate. These companies can adopt pricing strategies that position them as better alternatives than their competition.

However, the majority of businesses do not have this advantage. How can these companies increase their customer lifetime value amidst such obvious disadvantages?

1. Optimize Your Customer Onboarding Process

Customer onboarding is the first point of contact your target audience will likely have with your company after they decide to become customers. It is the opportunity for you to impress and retain them in the long haul.

Except you deliberately want your customers to not stay beyond their first few purchases, optimizing your onboarding process is a necessity. It allows customers to get familiar with the products and services that your company is offering.

You know your onboarding process is fully optimized when it motivates customers to return for more purchases over and over again. In the process of this positive customer-business relationship, your customer lifetime value is increasing.

One of the best and most effective practices for customer onboarding is under-promising but over-delivering on your brand promise. When you provide more value than you promised your customers, they will naturally be overwhelmed by the extras they get and be thrilled to return to your brand for more repeat business.

Many brands made the huge mistake of making claims that they cannot fulfill. With churn rates at their highest after a customer's single interaction with a company, you must make the first impression count.

Customers often need more information about how your products’ features and benefits can positively impact their lives. For service businesses, effective customer onboarding is as simple as paying attention to first-time customers and demonstrating a dedication to customer service.

Poor onboarding is one of the leading causes of churn. Optimizing your customer onboarding process helps lower your churn rate, leading to better customer lifetime value (CLV).

2. Effective Communication with Customers

A quick way to increase your customer lifetime value is to always have an open line of communication between the company and the customer. It strengthens the customer-company relationship. Responding to feedback from customers, even negative comments, is important.

You can send out customer satisfaction surveys through Net Promoter Score (NPS), a one-question survey that asks your customers the likelihood of recommending your brand to friends and family on a 0-10 scale.

Based on their response, customers that give you a 9-10 score are promoters, those that give you a 7-8 score are passives, and those that give you a 0-6 score are detractors. You can calculate your NPS score by subtracting the percentage of detractors from the percentage of promoters.

A high NPS score helps you increase your CLV since you have more happy customers who are likely to keep a long-term relationship with your business than unhappy ones. It also lowers your churn rate, improves your average customer lifespan in months (ALT), and expands your client base.

Customers want to know there is someone they can communicate to for help with any issues with their purchase and appreciate it when their voices can be heard.

You need to engage and build a strong relationship with your customers to boost your customer lifetime value. Some of the best practices to do this include regular check-ins, social listening, accepting and implementing customer feedback, and improving your customer service.

There are several ways to improve your customer service and make it excellent. They include offering existing customers personalized services, putting it in place with a clear and easy refund policy, and omnichannel customer support.

Customer relationship management (CRM) helps businesses to manage their relationship with both existing and potential customers. You can use the best CRM software such as Hubspot, Salesforce, and Salesforce alternatives to effectively communicate with your customers.

A whopping one-third of customers will not return to patronize a brand where they experienced poor customer service. The availability of customer service is one of the considerations that customers use to choose a brand to use.

Lack of effective communication with customers will affect the average order value (AOV), average customer lifespan in months (ALT), and the average number of transactions per month (T). According to Retently, weak relationships with customers account for 16% of the average customer churn.

Effective communication also applies to the sales and marketing copy the company uses. Test your copy to ensure it communicates effectively with your target audience. You can measure the effectiveness of your communication by accessing your ad conversion rate and churn rate.

3. Loyalty Program

A loyalty program is an excellent way of personalizing the customer experience and providing incentives for repeat purchases. Some common loyalty programs offer discounts and reward points that can be converted into prizes. For example, a coffee company can offer customers one pack of coffee free when they purchase five packs.

For loyalty programs to work, the incentives have to be attractive enough for customers to want to take advantage of them. Loyalty programs reward both the customers and the company.

The customers get more value for their money while the company gets rewarded with an increase in customer lifetime value.

Loyalty programs help increase your customer lifetime value by touching virtually all the CLV formula inputs. It increases the average number of transactions per month, average order value, and average gross margin as customers spend more money in the period. Loyalty programs also have a positive effect on the average customer lifespan in months

4. Re-activating Lost Customers

Re-activating lost customers who have previously had some experience with your brand is a proven tactic to improve your customer lifetime value. You can re-engage customers by sending a simple reminder message of the company to increase brand recognition.

If you sell products that have a shelf life, you can generate more purchases by reactivating lost customers. Due to their time-sensitive nature, customers are open to making another purchase.

Re-activating lost customers increases the average number of transactions per month a business would have generated and its average gross margin.

5. Increase Your Average Order Value

Increasing your average order value is one of the best ways to improve your customer lifetime value. When a customer visits your online store, adds products to the cart, and is about to check out, you can offer relevant products that complement the ones they are about to buy.

Doing this can make the customers add other complementary products to their purchase, thus increasing the average order value.

Big multinational companies like McDonald’s and Amazon make use of upselling and cross-sell tactics to increase the average order value of their purchase.

Amazon always shows you related products to the one you want to buy and bundles them in a group price to tempt you to spend more.

McDonald’s is famous for upselling you on its tasty treats and desserts just before you finish placing your order.

Subscription-based businesses can also increase their average order value by making their annual billing option cheaper compared to the monthly payment option.

Annual subscriptions make it easy for you to forecast and predict your revenue. Increasing your average order value increases your average gross margin, which impacts your customer lifetime value positively.

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