Did you know that you can easily calculate the value a customer brings to your business? The so-called Customer Lifetime Value (abbreviation: CLV; also known as customer value) is an important metric in business administration that can be used to determine the profitability of an individual customer relationship.
Term: What is Customer Lifetime Value (CLV)?
Customer Lifetime Value, or CLV for short, encompasses all transactions that, on average, each customer generates for a company over the course of a business relationship.
Each individual customer has a specific value to your business. This value is made up of all the revenue and expenses that customers generate for your business throughout the entire customer relationship—known as the customer lifetime cycle (CLC).
These transactions may also take place in the future and include expenses for customer acquisition, marketing activities, and services, as well as, theoretically, returns and refunds due to exchanges or warranty or guarantee claims. The use of services can also be included—so it’s not just about the monetary value of products sold.
Why is Customer Lifetime Value (CLV) important for your business?
Now you're probably wondering why you should calculate CLV—or Customer Lifetime Value—in the first place, and how your business can benefit from it.
CLV as a planning tool
Customer value is determined in order to plan marketing activities and the required budget in a targeted manner. This means that all necessary marketing measures can be individually tailored to specific customers or customer segments.
The higher the calculated value, the more significant that individual customer is to a business, and the more of the budget can be allocated to those customer relationships with confidence.
Using customer lifetime value, all available marketing resources can be effectively allocated and utilized for customer relationship management (Customer Relationship Management) can be effectively allocated and utilized. It forms the basis for determining the available budget for marketing, sales, and production and for using it efficiently over the course of the customer’s lifetime.
CLV Formula: How to Calculate Customer Lifetime Value (CLV)
There are two ways to calculate customer lifetime value:
- In the simple version , the customer's total purchases over the course of the customer relationship are added up, and the service fees are deducted from that total.
- The somewhat more complex calculation also includes predictions about the customer's future purchases. In addition, the customer's expenses and the discounting of capital must be factored in.
The formula for this (Variant 2) is as follows:
Meaning of the Individual Components of the CLV Calculation
- T = expected duration of the business relationship
- t = time interval (t = 0, 1, 2, … n)
- et = expected revenue from the customer during time period t
- at = expected expenses for customer care, service, etc.
- i = discount factor assumed for the estimated duration of the business relationship
Criticism of the CLV calculation
As can be seen from the second calculation, determining the CLV involves a high degree of uncertainty due to the forecasting factor>. Both estimating the expected duration of a customer relationship and accurately calculating customer-specific spending are difficult to predict. In practice, therefore, empirical values or industry benchmarks are usually used.
Nevertheless, calculating the value of individual or multiple customer relationships is important for every company, even if there is a certain degree of uncertainty involved. The more empirical data available, the more accurate the result.
How can you specifically positively influence Customer Lifetime Value (CLV)?
Once the CLV has been calculated, the question arises as to how it can be improved. There are also a variety of ways to increase customer value. As the Customer Lifetime Value formula makes clear, the following metrics are key factors that influence the result:
- Cost of customer service
- Average order value
- Duration of the business relationship
- Frequency of Purchases
Potential for improvement based on key performance indicators
This points to opportunities for improvement at precisely these levels. It is advisable to first analyze the various areas of the company and identify its strengths and weaknesses in order to be able to work with them.
The fact is: Acquiring a new customer is up to 10 times as expensive as retaining a regular customer.
For this reason, it’s extremely important to make new customer acquisition as efficient as possible and to constantly keep track of the existing processes involved. And, when necessary, to continually adapt and optimize them in response to changing conditions. In the long run, this will have a positive impact on your revenue.
Keyword: Customer Service
Are you perhaps allocating too few resources to customer service, your complaint management, and customer retention? To increase customer value, it makes perfect sense to invest in customer retention measures in order to extend the duration of the customer relationship. For example, by presenting a professional image and offering friendly advice, your customers will feel particularly well taken care of.
Stay top of mind with your customers. Through email marketing or push notifications, you can stay in constant contact with your customers so that you’ll be considered again as their go-to provider the next time the opportunity arises. This opportunity is especially relevant during times of crisis.
Upsells and special offers for selected customers
Offer your customers complementary products (known as upsells or cross-sells) that go well with your main product. Show that you’re knowledgeable and well-positioned in your field.
Offer special deals to your loyal customers to reward them for their loyalty. Rewards make people happy, so it’s important to use reward systems.
All of this means that, by spending more efficiently on customer care and improving service, you’ll ultimately have more satisfied customers. These customers will feel a stronger connection to the company, remain in the business relationship longer, and place greater trust in it.
Strengthen customer loyalty, reduce willingness to switch
This reduces customer churn, increases purchase frequency and revenue, and turns customers into brand ambassadors who, in turn, attract new customers for you time and time again. All in all, this leads to an increase in customer value and customer lifetime value—so these are well-considered investments!
Numerous benefits resulting from CLV calculations
Customer Lifetime Value (CLV) helps you determine the value of your customers and, as a result, improve your customer acquisition and retention strategies in a targeted way. This, in turn, leads to positive effects on your revenue.
This allows you to focus on the most promising segment of your customer base (the so-called A-customers among your existing customers) and prioritize them with appropriate marketing and sales campaigns while providing them with personalized support.
FAQ: Frequently Asked Questions About Customer Lifetime Value
What is the Customer Lifetime Value (CLV)?
Customer Lifetime Value encompasses all transactions that a company generates on average per customer over the course of a business relationship. It consists of all revenue and expenses generated by customers throughout the entire customer relationship—the Customer Lifetime Cycle (CLC).
How do you calculate customer lifetime value?
There are two approaches. In the simpler approach, the total value of past purchases is calculated over the duration of the customer relationship, and customer service costs are subtracted from that total. The more complex approach also takes into account forecasts of future purchases, the customer’s spending, and the discounting of capital.
What factors influence CLV?
Four key factors in particular: customer service costs, average cart value, the duration of the customer relationship, and purchase frequency. Measures to increase customer value focus precisely on these areas.
Is customer retention more cost-effective than acquiring new customers?
Yes. Acquiring a new customer can cost up to 10 times as much as retaining a regular customer. That’s why it’s worth investing in customer retention measures.
How reliable is the calculated CLV?
The calculation involves some uncertainty due to the forecasting factor: Both the expected duration of a customer relationship and the exact customer-specific expenditures are difficult to predict. In practice, therefore, empirical data or industry benchmarks are used—and the more empirical data available, the more accurate the result.
