how is the CLV (Customer Lifetime Value) calculated?

According to customer loyalty research, companies with higher loyalty rates grow 2.5 times faster than their competitors.

To achieve that loyalty, one of the four main strategies they use to increase loyalty rates is the creation of systems to calculate customer lifetime value, better known as customer lifetime value (CLTV).

what is CLTV?

Customer lifetime value (CLV) is a forecast of how much money a customer will spend with our company for as long as he or she is a loyal customer .

This forecast helps us to quantify as accurately as possible the monetary value that a customer represents for the company for as long as a business relationship exists.

According to the same Econsultancy report, 91% of organisations say that predictive analytics using AI is the most powerful technique for improving CLTV.

This concept allows us to better understand why it is more profitable to invest in customer retention rather than acquisition, as a loyal customer makes multiple purchases over time, whereas a recent customer is not as engaged with your business and may more easily turn to a competitor.

Some statistics on acquisition and retention indicate that attracting a new customer costs 5 times more than retaining an old one. This is because of all the money and effort invested in a customer who, perhaps after the first transaction, may end up abandoning the brand.

why is this important?

In marketing, the customer lifecycle is very important as it is used to calculate the monetary value of each of these cases.

The aim is clear: to carry out appropriate and profitable actions for the brand. To do this, it will also be essential to understand the journey and experiences that the consumer has at each stage of the buying process.

Calculating Customer Lifetime Value is closely related to loyalty, and is important when it comes to knowing the relationship between business and customer in order to know how to invest our time and money wisely. For example, a customer who has been buying the same brand of coffee for a lifetime is more profitable and therefore more important to retain than one who only buys it occasionally.

According to a study by Arya Systems, more than 75% of senior executives in the US say that CLTV is a very valuable indicator for their companies. Companies that already create a Customer Lifetime Value report in their digital strategies consider it a very effective measure of customer lifetime value:

• Considering new investments in the technology area.
• Measure the profitability of our investments.
• Reduce costs.
• Compare customer segments.

In order to calculate it, it is necessary to group data of each customer and define exactly the values that will be part of the CLTV. Another very useful tool is the Buyer Persona, which allows us to have in the spotlight what our ideal customer is and see if it corresponds to the current customer and its life cycle.

how is it calculated?

To better understand the procedure, let's see how to calculate the customer lifetime value through an example:

Let's imagine that we have a hotel, where we have a customer who visits us every summer with his family or a group of friends, and who, apart from staying at the hotel, also books many of the dinners at the hotel, enjoys our spa service and uses us to book tickets to shows. In other words, a loyal customer who enjoys all our services.

CLTV 1 = Average spend per week x Number of weeks in the year x Number of years

With this information, we can now estimate an initial CLTV.

To do this, let's assume that the lifetime of our client is 10 years (considering that a year has 52 weeks), then we apply the following formula:

CLTV 1 = 10,68$ x 52 x 10

CLTV 1 = 5,554$

This is a simple way to have an approximation of the CLTV for our hotel service, although it is really very basic. We can see that in this initial calculation we are not considering the cost we assume to be able to offer you all these services.

So, for a more accurate estimate we must include the contribution margin in the customer lifetime value formula.

Let's assume that the final contribution margin is 25%. Therefore, a better estimate of the CLTV for our customers is obtained by the following formula:

CLTV 2 = CLTV 1 x Contribution Margin

CLTV 2 = 5,554$ x 25% CLTV 2 = 5,554$ x 25% CLTV 2 = 5,554$ x 25% CLTV 2

CLTV 2 = 1,388$

As you can see, this last customer lifetime value is more accurate than the previous one and is a better guide if we use it to make business decisions.

Defining your own Customer Lifetime Value allows you to make the most of every point of contact that the customer has with your business, offer a better service and encourage loyalty, without forgetting to establish a strategy so that the sporadic customer comes back to us and becomes a loyal customer.

what decisions should you make when you know the lifetime value of a customer?

The most direct application of knowing the customer lifetime value is in being able to decide how much to spend on acquiring a new customer, thanks to the forecast of how much profit this will generate for the company.

Therefore, the fundamental rule to follow is that you should never spend more on the acquisition than the lifetime value of the customer, as this would obviously not be profitable. In this sense, the idea is always to spend as little as possible.

That is why, according to research on customer loyalty conducted by Bain & Company and Frederick Reichheld, creator of the Net Promoter Score (NPS), improving customer retention rates by 5% increases profits for the company by between 25% and almost 100%.

have you already calculated the customer lifetime value of your business? If you haven't done it yet, we recommend you to follow the steps explained in this post and start optimising your marketing strategy and improve your business quickly and easily.

{{cta('e03ded89-c98d-46eb-b25a-496d0f3ec890','justifycenter')}}