hat is CLV and Why it is the Most Important Metric for Your Startup?
How can one make sure of the fact that their company is succeeding?
Well, one of the obvious answers could be by looking at operation metrics such as revenue, profit margins or sales and then comparing these figures with one’s own annual projections, historical records or number of competitors in the market.
But, these are not the only metrics one should adhere to especially if they want to assess their company’s success in long-term.
One of the most important metrics whose importance has been understated for a long time is CLV or Customer Lifetime Value. As the name suggests, CLV refers to the net revenue a customer would be bringing to the company during his lifetime.
While marketers have been repeatedly talking about the importance of CLV, surprisingly the term is not much known. A 2018 UK study revealed that “only 34% of the marketers who participated in the survey really knew about CLV and its real value in startup growth, while only 24% of them agreed that CLV was being calculated properly to assess their company’s success.”
What is CLV or Customer lifetime value?
If we speak of definition, Customer lifetime value (CLV), customer profitability analysis or simply User Lifetime Value (LTV) is a metric used to calculate a customer’s monetary worth to a company by factoring his relationship with the company over time.
CLV is a crucial metric that lets companies assess how much they should spend to acquire a new customer and to retain already existing ones.
What are the benefits of CLV?
1) CLV helps to design better Customer Acquisition Strategies
Paying attention to CLV can drastically change the economics of your customer acquisition plan.
For instance, if the CLV of a customer is $2000, you know how much you can spend to acquire a customer.
No wonder why companies like Uber, Amazon and others offer lavish discounts and offers to get a new customer in their door. Because they know the lifetime value of that customer is far higher to make up for any initial loss.
2) CLV Allows Better Customer Segmentation
Recognizing the company’s most valuable customers (ones with highest CLV) will give an insight on who should one target in terms of demographics.
3) Reducing Churn for Better Customer Retention
Knowing CLV of a customer will give a better insight to decide if the customer is worth retaining and then decide on implementing steps which can encourage them to come back to using your services.
4) CLV helps in Analysing Payback Period
The payback period determines how long the business will take to recover its acquisition cost from a customer.
A long payback period could directly associate more risk to the business.
For instance, if a customer churns before the payback period, the business would be bearing a loss in regard to that customer. Alternatively, if a customer runs past its payback period, any purchase from him will bring value to the business.
5) CLV Helps in Improving Customer Service
CLV can be deployed as an early warning sign to managed defection rate and complaints.
For instance, if a customer with low CLV complains about a particular issue, is it necessary to investigate the problem to the nth degree? Offering a solution and ensuring the fact that customer leaves happy is important but at the same time investing too many resources on chasing an already sinking ship is also not a wise decision to go forward.
The Math Behind CLV: How to calculate it?
There are a wide plethora of ways when it comes to calculating CLV for your company which we will look into detail one by one.
The Simple Formulae
The simplest way to determining CLV is by subtracting the initial cost of customer acquisition from the total revenue earned from a customer.
Total Revenue Earned from Customer= (Annual revenue per customer * Customer relationship in years)
CLV = (Annual revenue per customer * Customer relationship in years) minus Customer Acquisition Cost
Here is a quick illustration of the above formula:
Let us assume a SaaS company produces $4000 each year from every customer that has an average lifespan of 3 years and a initial CAC of $2000 for every customer. Hence applying the formulae, CLV should be calculated as:
This simple method of calculating CLV can prove effective when the profit contribution from customer remains consistent. For example: If you provide a subscription-based service with only two models, then customers can be expected to provide a consistent source of revenue.
Historic and Predictive CLV
In terms of data used, the methods of calculating CLV can be divided into historic and predictive.
It is defined as the sum of gross profits from all the past purchases of an individual customer. The formulae used is:
CLV= (Purchase 1 +Purchase 2+……. + Purchase N) * AGM
Where purchase N stands for the purchase value and AGM stands for Average Gross Margin.
Predictive method of calculating CLV is considered a more complete method which helps to project how much revenue a customer will be generating for the business during the course of his relationship with the business.
- This method makes use of certain behavioural patterns and transaction history that is used to determine the current value of the customer as well to forecast how much will the customer evolve during his lifetime with the brand.
- The accuracy of this methods improves over time as more and more data pertaining to a customer is collected with every purchase.
There are different formulas available to calculate predictive CLV, but here we will focus one of the simplest ways through which a predictive CLV can be determined:
CLV = (P × AOV) × AGM) × ALT
Where P stands for average number of monthly purchases, AOV stands for Average Order Value and AGM for Average Gross Margin and Alt for average lifetime of a customer.
How to improve your company’s CLV?
There are myriad ways that can be used to enhance the CLV of your company. Some of them are as follows:
Keeping in touch with your most valuable customers can be a good way to increase CLV of your brand. For instance: online retailers can make use of email reminders to let customers know about new products and offers thus encouraging them to come back to the company’s website.
Long-term customer relationships are built on the base of customer loyalty hence marketers should focus on devising strategies that can improve customer-brand relationship letting customers stick loyal to them and not switch to other brands.
Refining company’s marketing strategies to target most valued customers who are likely to make repeated purchases can be a powerful way of improving CLV.
Cross Selling and Upselling
These two marketing strategies can be effectively used to improve CLV. Though both these terms are used interchangeably, they work in tandem.
Cross Selling is the practice of encouraging customers to buy a higher end product than one in question while Upselling pushes customers to buy related or complementary items alongside the items they are already buying.
Let us take the example of e-commerce industry to understand the two terms more clearly.
- Cross-selling is a highly effective tactic in e-commerce that comes in the forefront on product pages, during checkout. It aims at targeting repeat purchases and introducing a wide catalogue of services to customers.
- Similarly, upselling involves showing comparison charts to market higher-end products to customers. Offering suggestions for better versions or models of a product customers are looking forward to buying can leave them more satisfied with the purchase, encouraging them to come back for their future needs.
Introducing Loyalty programs with additional perks can be one of the most effective ways of targeting customer retention as well as improving customer-brand rapport for years to come.
- Special discounts, freebies or free shipping can encourage customers to make repetitive purchases.
- Repeat customers are always more valuable as compared to ones that make a single purchase – as it costs less to retain a customer than to acquire a new one.
Whether you are a small brand with a limited customer base or a reputed firm with millions of loyal customers, determining your company’s CLV is a robust way to earn customer lifetime value.
Factoring your company’s CLV effectively will act as a recipe for your business success that can leave your less-data driven competitors struggling while you will be dancing in your company’s success bash.
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