How do you calculate customer lifetime value? Why is it so important to the success of your marketing campaigns and to your business overall? Let’s answer those questions and provide the tools you need to calculate this most valuable concept.
What is Customer Lifetime Value?
Customer Lifetime Value is how much you expect to make over the lifetime of a customer time with your company. It’s not about how much money you make on a particular sale, but how many sales you can expect going forward from that sale. This is going to directly inform how much you can spend on acquiring new customers (read a nice breakdown on calculating CLV from Qualtrics).
This formula also explains why companies are often willing to pay more to acquire a new customer, than the margins for an initial sale would seem to allow. If you’ve seen Google Pay-Per-Click rates that are astronomical for industries such as law and healthcare, you now know why. Any industry that charges either high prices up front or expects to have the customers for a long period of time (i.e. a subscription service) will often have a very high cost of customer acquisition.
Above is a simple (but flawed) calculator for customer lifetime value. Try it out, but make sure to jump to the next section before you use the numbers. Be thinking: “what is the problem with this formula” along the way.
How to use our customer lifetime value calculator
To get the most out of this Customer Lifetime Value calculator, start by gathering accurate data. This means looking at your sales records to determine the average amount customers spend per transaction and how often they make purchases. You’ll also need to estimate how long customers typically remain loyal to your brand. Customer retention rate, or the percentage of customers who continue to buy from you over time, is important as well. These figures might require some analysis and may vary depending on your specific business and industry.
Once you’ve collected your data, input the values carefully into the corresponding fields in the calculator. Double-check your entries to ensure accuracy. Remember that even small errors in your input can significantly impact the calculated CLV. If you’re unsure about any of the values, consider seeking advice from a financial professional or using industry benchmarks as a reference.
With your data entered, simply click the “Calculate” button. The calculator will process the information and provide you with your estimated Customer Lifetime Value. This figure represents the average revenue you can expect to generate from a typical customer throughout their relationship with your business. It’s a powerful metric that can guide your marketing and customer retention strategies.
Understanding your CLV helps you make informed decisions about customer acquisition, retention, and overall business growth. You can use it to evaluate the effectiveness of your marketing campaigns, identify high-value customer segments, and determine how much you can afford to spend to acquire new customers. Remember that CLV is a dynamic metric; recalculate it periodically as your business evolves and customer behavior changes.
What Was The Problem With This CLV Calculator?
Perhaps the most important rule of analytics or data analysis of any type is that one must be extremely careful about what you average. If you have different products that the customer will buy along the way, you might realize that all customers are not in fact the same. A lesson from statistics, curtesy of Major League Baseball is Simpson’s Paradox:
In both years 1995 and 1996, Derek Jeter had a lower batting average than David Justice however Derek Jeter’s combined batting average for the two years was higher than David Justice. How did it happen?
Don’t freak out. The stat is real and it’s actually pretty intuitive. Jeter’s average of .250 in 1995 and .314 in 1996, is less than Justice’s .253 and .321 respectively. However, in 1996, Jeter took more at bat.
Year Batter | 1995 | 1996 | Combined | |||
|---|---|---|---|---|---|---|
| Derek Jeter | 12/48 | .250 | 183/582 | .314 | 195/630 | .310 |
| David Justice | 104/411 | .253 | 45/140 | .321 | 149/551 | .270 |
Example of a More Advanced Customer Lifetime Value Calculator
With this in mind, if you sell a variety of products (especially if there’s a great range to the cost of the products), you’re going to want to account for segmentation. Different customers buy different products and your CLV needs to attempt to account for it.
In whatever CLV calculator you use, you’ll want to add a “Customer Segment” dropdown where you can select the customer segment. Each segment should be divided by a value that acts as a multiplier in the CLV calculation. This adds another layer of granularity to your CLV calculations and can provide a more accurate representation of the CLV for different customer segments.
Now keep in mind, we still have the averaging problem. Simply lumping customers into these generic categories “high spending, long-term” customers is fairly simple. Depending on the type of company, the industry and the different products you have, you will likely need to adjust your formula.