What is Customer Lifetime Value (& How Do You Calculate It)

What are your customers worth?

A lot of us would say, "they're priceless." And while that may be true, it doesn't actually provide a ton of valuable detail about your customer base.

You know what does? Customer lifetime value, or CLV, which measures the numerical value of your customers.

CLV puts a number on the average journey your customer takes before they become part of your clientele - better known as the customer journey - and identifies your most loyal clients. It's a key metric for any business, small or large, because it helps you retain the most valuable portion of your customer base.

Let's dive into what that all means for you. In this post, I'll explain customer lifetime value and how to calculate it for your business. We'll also review an example and discuss the average lifetime value of different industries.

Note: Some organizations use LTV to represent customer lifetime value. While both acronyms are acceptable, we will use CLV for this post.

To calculate customer lifetime value, you'll need to obtain the following metrics. I'll dive into each in more detail, but prepare to do some math for now.

• Customer Value
• Customer Lifespan
• Average Purchase Value
• Average Number of Purchases

Customer lifetime value is important for both big and small businesses. It helps you understand who your most valuable customers are so you can keep them happy and loyal to your brand.

They shop at your stores the most, spend more than other customers, and are likely huge advocates of your brand. Knowing who these individuals are will help you keep them happy and returning to your business over time.

How is customer lifetime value used in marketing?

If you have a CRM, you can track the lifetime value of each contact in your database. CRMs record interactions so you know when someone bought something from your business. You can use this information to calculate CLV and divide contacts into groups in your CRM. Grouping contacts will make it easier to send personalized marketing content that effectively generates sales.

It will also make it easier to identify customers who have had a negative experience with your business. If they're labeled "high CLV" in your CRM, then you'll know this customer is worth going the extra mile for.

Calculating CLV is easy. The tricky part is gathering the data needed to perform the calculation. Let's review everything you need in the section below.

How to Calculate Customer Lifetime Value

To calculate customer lifetime value, you'll first calculate customer value, or how much a customer spends at your business. Then, you can multiply this by the average customer lifespan to obtain customer lifetime value.

Confused? Don't worry; I'll break it down for you.

Customer Lifetime Value Formula

Here are the two formulas you'll need to calculate customer lifetime value.

I'll get into what each of these things actually mean in a bit.

First, we'll need to calculate customer value, which means we'll also need a few other pieces of information. To simplify things, let's look at each metric individually and then combine them in a final example.

Customer Lifetime Value Metrics

Here's everything we will need to calculate customer lifetime value. You can apply these metrics to individual customers or your entire customer base.

1. Average Purchase Value

The average purchase value is the typical amount someone spends on a single purchase at your business. To calculate this metric, we'll divide the total revenue from this customer by their total purchases.

2. Purchase Frequency

Purchase frequency is how often someone buys something from your business. If it's one customer, you just have to look at your payment software to see how many times they've purchased something. If you're looking to calculate this metric for your entire business, you'll divide the total number of purchases made at your business by your total number of customers.

3. Customer Value

Now that you have the average purchase value and purchase frequency, you can calculate customer value. Customer value tells you how valuable this customer has been to your business. It's a historical metric that we can use to predict their overall lifetime value.

To calculate customer value, multiply your average purchase value by your purchase frequency.

4. Average Customer Lifespan

Customer lifespan refers to how long your customers shop with your business. You might have some customers who made one purchase and never returned, and others who are loyal clients you've known for years.

To calculate your average customer lifespan, you first add up all the years that every customer has been active at your business. For example, if three customers have worked with you for ten years, your sum would be thirty years. Then, divide this value by the number of customers at your business.

At this point, you should have everything you need to calculate customer lifetime value. So, let's see it in action with an example.

Customer Lifetime Value Example

Let's pretend we own a roofing business. We'll call it "Regina's Roof Repair."

Our business has been around for almost two years. We have 25 total customers and have generated roughly $125K. Each customer has also made two purchases in the last two years.

Now, let's calculate customer lifetime value for our roofing business.

Step 1: Calculate the average purchase value.

The first data point we'll need is the average purchase value. We'll obtain it by dividing total revenue by total purchases. We know the business made $125K, and each customer made two purchases.

To calculate the average purchase value, we can divide total revenue by total purchases.

Average Purchase Value = $125K ÷ 50 Purchases = $2,500 per Purchase

Step 2: Calculate purchase frequency.

Next, we need to calculate purchase frequency. The business has only been open for two years, and we know all the customers are still active and have made two purchases.

To calculate purchase frequency, we'll divide total purchases by total customers.

Average Purchase Frequency = (50 Purchases ÷ 25 Customers) / 2 Years = 1 Purchase/Year

Step 3: Calculate customer value.

We now have the data points needed to calculate customer value. Let's multiply our average purchase value by our average purchase frequency.

Customer Value = $2,500 x 1 Purchase/Year = $2,500

Step 4: Calculate average customer lifespan.

Before calculating customer lifetime value, we'll need to obtain the average customer lifespan. In this case, we know it's two years because that's how long the business has been open.

If we didn't know that, here's how we would calculate this metric.

Step 5: Calculate customer lifetime value.

Now, let's put it all together and calculate the average customer lifetime value for this business.

Customer Lifetime Value = $2,500 x 2 years = $5,000

That means that the average customer at our roofing business spends $5,000 in their lifetime.

That's the traditional approach to customer lifetime value. However, AI has given us a new model for predicting this metric. We'll explain the difference in the section below.

Customer Lifetime Value Models

You can use two models to calculate customer lifetime value: historical and predictive.

Historical Customer Lifetime Value

The approach we just used is called historical lifetime value. It uses data from your revenue and purchase history to calculate CLV. It's a generic formula that any business can use, and it makes predictions based on your current customer behavior.

The problem is that customers change, so a one-size-fits-all formula isn't always the most accurate approach. While it's great for getting a pulse on your customer base, it lacks the predictive insights that AI can provide.

Customer Lifetime Value Prediction

Predictive customer lifetime value uses AI to forecast CLV over time. It still works with the same data as before, but it considers a variety of other factors, too.

Your business might not need this tool. It's often used by companies with large datasets and multiple variables to work through. But, if you're interested, it's available with most customer service software.

What is average customer lifetime value?

Average customer lifetime value applies to your entire customer base. It's not just the CLV of one person but the average of every customer at your business. It's a great metric for business owners because it shows how much revenue the average person generates for your business.

Average Customer Lifetime Value by Industry

Before we wrap up, let's look at some industry standards for customer lifetime value. These numbers were pulled from FirstPageSage and Metrilo, respectively.

• HVAC: $15,340
• Commercial Insurance: $125,190
• Healthcare Consulting: $96,937
• Pet Retail: $107
• Cosmetics: $190

Measuring Customer Lifetime Value

Every customer matters. But, some have a greater impact on your bottom line than others.

Customer lifetime value helps you identify your most loyal customers and understand what the average person means to your business. It's an important metric for any company, and it's something you should track over time. Use the formulas in this post to calculate CLV and leverage this data to retain your most valuable customers.

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