Most business owners know the average purchase amount they get from their customers (amount of sales divided by the number of purchases), but few bother to understand how much value customers give over the lifetime of their relationship with the company. Advertising and marketing is vital to the growth of any company, but knowing how much a customer is likely to spend while they’re doing business with you is important for setting the proper budgets (and expectations).
Customer Lifetime Value
Customer Lifetime Value (CLV) is a measure used in marketing to figure out just how much customers are purchasing over the lifetime of their relationship with the company. While it can be calculated exactly by setting up a spreadsheet with the purchase amounts and average length of relationship, an estimate of CLV is usually close enough for our purposes.
Let’s say that the typical customer spends $100/month and does business with you for 2 years. Your CLV is $2400. $100/month x 12 months = $1200 per year x 2 years = $2400.
Now that you know the CLV for your customers, you can use it to decide whether or not specific marketing and advertising efforts are worth the investment.
If you’re running advertising on a website and it’s costing you $3000/month to reach 100,000 people, but only has a click through rate of 0.3%, you’re paying $3000 to have 300 people click on your ad. If your conversion rate for your landing page is 5%, then 15 people per month are becoming customers. The CLV of these 15 people is each $2400, which is $36,000 over their business relationship with you. You’re spending $3000/month to gain $36,000 additional business each month.
Long-term vs. Short-term
In the previous example, if you had just used the initial purchase amount, $100, instead of CLV, you would have thought you were paying $3000/month for only $1500 of business (15 x $100), which doesn’t make sense. Just using the initial purchase amount ignores the long term value of a customer.
What if you had larger initial purchases but customers don’t stick around very long? If a typical customer purchases $1000 but only makes that one purchase, your CLV is much lower than the previous example ($1000 vs $2400). This means you have to spend enough to keep more customers coming through the pipeline because they aren’t sticking around.
Fixing What’s Broken
CLV helps pinpoint what may not be working as well as possible in the overall lifetime of a customer. If customers purchase $1000 from you but only do it once, there’s clearly an opportunity to try to increase repeat purchases. If you’re advertising and getting pretty good traffic to your landing page, but only a small percentage is converting from that point, there’s a place to improve.
CLV is a fairly easy measurement to calculate (especially estimated CLV, but even a true CLV isn’t too difficult) and can give you a very valuable understanding of what’s going on in terms of the value you’re receiving from your customers. Calculating a true CLV (instead of estimated) occasionally is a good idea to confirm your assumptions.
Do you use CLV? How do you calculate the long-term value of your customers?
(photo by Rich Brooks)