Calculating Customer Lifetime Value
Customer Lifetime Value (CLTV) is one of the most important metrics for understanding any business in any industry. By definition, CLTV is the predicted revenue a customer will generate throughout their entire relationship with a business. It is a useful metric that allows businesses to see how valuable customers are going to be. CLTV also helps determine how to maximize future marketing investments and spending on customer acquisition.
By understanding your CLTV, it takes the guessing out of SEM, PPC, retargeting campaigns, and spending on customer retention. It also helps determine what discounts and promotions should really be offered to your customers. CLTV is an incredibly valuable metric, but research shows that less than 5% of online businesses know their CLTV or how to calculate it (Sweet Tooth).
Unfortunately, this is mainly due to the fact that CLTV can be complicated and intimidating to figure out. If you Google it, you will see formulas that look like these.
Although these complex calculations will give you highly accurate values, they can be overkill for most online businesses. For a business that has not measured CLTV yet, it is a good idea to start with the following formula:
CLTV = CV x T = AOV x F x T
AOV (Average Order Value) = Total Revenue (365 days) / Number of Orders (365 days)
F (Purchases Frequency) = Total Orders (365 days) / Unique Customers (365 days)
CV (Customer Value) = Average Order Value (AOV) x Purchases Frequency (F)
T (Customer Lifetime) = time (years) before a customer churns. It is recommended using a (t) value of 1-3 years.
This formula only gives a rough approximation over a course of X time, but even using a basic calculation for CLTV puts you ahead of the competition. Most businesses have no idea what a customer is worth to them and having some idea of CLTV is better than no idea. Still, growing CLTV involves a lot of experimentation and crunching numbers to see what tactics are delivering results.
CLTV allows businesses to focus on their most profitable customers and make decisions that drive long-term success (which results in better ROI). Calculating CLTV is essential for businesses to get a real understanding of how valuable their customers actually are.
Ultimately, knowing your CLTV can lead to driving higher quality traffic, improving on-site engagement and, most importantly, increasing conversions and sales. With this knowledge, businesses can truly make the most out of their time and money.