Customer Lifetime Value. It doesn’t sound nearly as sexy as the word profit and is certainly not as exciting as a yearly bonus. However, this figure is so critical to your business that it has the potential to make or break it.
So what is it? In a nutshell, customer lifetime value is the average expected amount of sales revenue generated from a customer over the lifetime of their interaction with your goods and services. Sounds like a bit of a mouth full, but in practice it can be very easy to calculate. To get started, you’re going to need three important figures.
Average Sales Value
Take an average of the value of each transaction a customer has with you. Are they usually buying 2 items at a time, or are they buying 6? Are they premium products, or introductory offers? By taking an average of your sales to find the typical transaction amount, this will allow you to sum everything up with one figure.
Average Number of Repeats
If you are a high-ticket retailer that sells shower doors, this number will be fairly low unless you are selling to contractors. Compare this to a grocery store where customers can come in multiple times per week for various items. The bottom line is, by knowing how frequently your customers purchase from you, this will help in predicting their average value.
Average Retention Time
Remember back in high school when your best friend was with someone new every two weeks? Sounds like a stable relationship, doesn’t it? While hopefully your relationships with your customers are not so short lived, knowing how long to expect an average relationship to last is essential. This can be affected by your customer service experience and many other factors, but the longer it is, the more profit is possible. As a quick tip, make sure that your time period of retention is in the same units as the number of repeats. In other words, if a customer buys from you once per week, make sure that your retention time is also in weeks.
The Final Recipe
Now that we have all of the ingredients, it’s time to put it together. Follow the simple formula below to calculate the average lifetime value of a customer.
Customer Lifetime Value= Average Sale Value* Number of Repeats* Average Retention Time
Now What?
This figure has more value than just another marketing statistic. By knowing how much a new customer is worth, you can make decisions as to what an appropriate amount of spend is to acquire new ones. Are you considering providing a discount on your services for a limited time? By starting with the average value, you can determine how much room there is to do so without harming your business. Considering adding a new marketing channel? The CLV can give you a strong guide as to whether or not the new channel will be appropriate for you.
At the end of the day, knowing your CLV is essential for determining what decisions to make while still remaining profitable in the process. Once you do this, you are well on your way to becoming a more informed business owner.