Understanding Customer Lifetime Value
A widely recognized concept in marketing circles is customer lifetime value (CLV); however, not many business people without a marketing background understand what it is exactly or how to measure it properly. Customer lifetime value is the forecasting of net profits that connect to a specific customer during their lifetime relationship with a business. To state it more simply, CLV is the financial value of a customer relationship over the lifetime of your relationship with that customer.
Why It is Important
Customer lifetime value is important because it gives you an idea of the amount of repeat business you might be able to expect from a specific customer. This knowledge will assist you in deciding how much you can profitably invest in 'buying' this particular customer for your business.
Once you determine how much a customer buys and the frequency of their purchases, you will have a better understanding of how to manage your limited resources. Choosing between projects like customer retention programs or other services that you will need for keeping satisfied customers will be easier with the right knowledge.
How to Calculate CLV
The formula for calculating CLV is quite simple. It is the total gross profit of a customer over the lifetime of the relationship LESS marketing, advertising, and incremental service or product fulfillment costs. This EQUALS the customer lifetime value.
Here's a good example: Take a gym member who is spending $40 on a monthly basis for three years. The calculation for the CLV would be $40 x 36 months = $1,440 in total revenue (or $480 a year).
Thinking hypothetically, you can see why so many gyms, to drive traffic, offer new members free starter memberships. They know that if they are spending less than $480 for bringing in a new member, that member will eventually turn out to be profitable.
Running Your Business to Optimize CLV
It is helpful to think of CLV as a “catch and keep” strategy, rather than a “catch and release” tactic.
Below are only a few advantages that you will have by understanding fully and leveraging customer lifetime value. These include:
- Being able to recognize and set proper spending levels for marketing and customer acquisition.
- Understanding how to handle issues with customer service, when to give in and when to back off. You will know when the value is high enough to go the extra mile to retain the customer and when just to let them go.
- Knowing now how much you can spend on client gifts.
- Decision making will be easier when it comes to setting marketing budgets and spending for other areas of your business.
- Knowing now how to calculate commissions, incentives and bonuses to compensate your sales team.
Ultimately, it is difficult to run a thriving business if you do not invest in bringing in new customers and satisfying the ones you already have. By understanding customer lifetime value, you will realize that you miss investing in your creative marketing strategy. Companies that understand customer lifetime value, and act upon this knowledge, will gain a competitive advantage in the marketplace. Overall, a diligent CLV strategy enables businesses to improve marketing strategies to not only increase customer retention, but boost revenue.