In simple terms, Customer Lifetime Value is the financial value of your customer during their entire relationship with your business. You can think of it as an upper value of what your company would be prepared to spend on acquiring a new customer.
In marketing, knowing your customer’s lifetime value is extremely important because it helps you calculate ROI. For example, if a customer’s lifetime value is $200, and it costs you $100 to acquire a customer, then your customer acquisition cost is acceptable, and you should continue using the same acquisition strategy. On the other hand, if your customer acquisition cost equals or exceeds your customer lifetime value, then you need to go back to the drawing board.
How do you calculate CLV? Let’s assume you are new to CLV and keep the formula simple.
CLV = “Average Sale” x “No. of Repeat Sales” x “Average Retention Time”
Suppose we are calculating a CLV for a local restaurant where the average customer spends $38, and where most of our customers come back 10 times a year. Also, let’s assume our average customer retention is 2 years.
$38 (average sale) x 10 (repeat sales) x 2 (retention) = $760
Now that we have a dollar value associated with a customer ($760) we can plan our marketing efforts better. You have to keep in mind that not all customers are created equal. Attracting a price conscious customer (e.g. offering a heavy discount) may bring you a customer, but not a repeat customer. Obviously, any marketing efforts which attract too many one-time customers is a red flag. Therefore, CLV forces you to think long term – ‘how do we acquire a customer and keep them happy’, versus short-term thinking – ‘how do we acquire a customer’.
In summary, customer lifetime value (CLV) will help you 1) shape your customer acquisition strategy, 2) evaluate your marketing campaigns, and 3) measure the effectiveness of your customer loyalty programs.