Customer Lifetime Value

Customer Lifetime Value (CLV) is a powerful, yet often overlooked, metric in business. It can help us make better decisions when it comes to marketing, sales and customer service - all of which make a difference to our bottom line… profit. In this blog we explain what CLV is and how to calculate and use it in your business.

what is Customer lifetime value?

If I asked you to think about the value a customer brings to your business, you will likely bring to mind the amount of money they spend. The concept of Customer Lifetime Value (CLV), however, orients us to a different way of thinking. 

CLV is the total net profit that a business can attribute to a customer. Instead of considering the value of a customer by how much they spend in a single transaction, it looks at the long term value that a customer brings to our business.

how do you calculate clV?

To calculate CLV you need to identify the following:

• Average purchase value. The amount on average that a customer spends at each transaction

• Net profit margin. The percentage of your revenue that is left after you have deducted all your business expenses 

• Purchase frequency. How often a customer makes a purchase within a given time frame

• Customer lifespan. The average length of time a customer remains a customer

You can then calculate CLV as:

Average sales price (£)  x  net margin (%)  x  purchase frequency  x  customer lifespan

There may be other things that are relevant to incorporate into this calculation, depending on your industry and business model. For example, if on average a customer refers one other customer to your business, this should be included.

Example 1

Imagine that I run a consulting business where the average fee for a project is £5,000 with a net profit of 20%. Let’s say on average I sell three projects to a client over the course of 7 years, before they move on. It may be that each client recommends one other client to my firm. In this case, my Customer Lifetime Value is:

£5,000 fee x 20% margin x 3 projects x 2 clients = £6,000

Example 2

Now let’s imagine I run a coffee shop. The basket spend of my average customer might be £6 with a net profit of 5%. If they buy from my shop 3 days a week for 10 years then my Customer Lifetime Value is:

£6 spend x 5% margin x 3 days x 48 weeks x 10 years = £432

using customer lifetime value in your business

So, what does this mean for your business? 

Marketing and sales

CLV is an important parameter when it comes to marketing and sales. It sets a limit to the amount we should spend when it comes to acquiring new customers. Once the cost of acquiring a new customer exceeds their lifetime value, we are losing money.

Customer loyalty

Retaining our existing customers also costs something - there is an investment of time (and money) that goes into delivering excellent service. However, the cost of retaining an existing customer is almost always much lower than the cost of acquiring a new customer.

Retaining customers not only costs us less; improving customer lifespan increases our CLV (and profitability). Once we understand that, we are more likely to focus on and adopt strategies that foster customer loyalty.

It’s about time

One of the most powerful applications of CLV is about time. As a business owner, the biggest investment you likely make in your business is your time. Where does your time have the most value? Let’s return to the example of the consulting business.

The first place I could invest my time is in delivering the project work for customers. Let’s say a typical project takes 20 days of work. The value to the business of a day of my time in delivery is:

£5,000 project value / 20 days work = £250 per day

What if I invest my time in winning the next project? Let’s say it takes one day to write a proposal and I have to write two proposals to win one. The value to the business of a day of my time in marketing is:

£6,000 CLV / 2 days to win one customer = £,3000

In this example, it is clear that a day spent on winning the next project is more valuable to the business than a day spent delivering the work. Not only that, but each day spent delivering the work is a day that I can’t win the next project. That costs me something. It costs me:

£3,000 - £250 = £2,750 per day

The idea, in small business, that we could (or would want to) abandon delivery and spend our time entirely on marketing is not plausible. Nevertheless, when we are mindful of the different value of our time spent in different areas of the business, we can begin to shift our focus - even incrementally. That might mean delegating tasks, streamlining processes, or simply allocating a dedicated portion of each week to higher value activities.