Common wisdom tells us that keeping current customers is more profitable than acquiring new customers. With this in mind, businesses are wise to focus on enriching customer lifetime value, or CLV, even more carefully than pursuing new leads. Simply put, a customer’s CLV is the amount of profit your company can expect to generate from a customer, for as long as you do business with the customer.
There are many formulas for calculating CLV, and there are even more software packages that will crunch the numbers for you, based on your data. The basic equation examines a few key elements of every transaction: average sale, number of repeat sales, expected retention time, and profit margin. The simplest way to arrive at this number is to deduct what you spent to acquire and serve a customer from the revenue generated from that customer.
The CLV exercise makes one thing quite clear: not all customers are equally valuable to your company. Knowing just a few baseline variables will tell you the relative value of a current customer. Even more importantly, they can serve as a template for how to target better customers in the future. Figuring out how much value each customer adds to your bottom line allows you to be most efficient with your marketing and product development investment.
Know Your Numbers
What does it cost your company to acquire a new customer? What’s the average amount a customer spends per purchase over their lifetime? What does the purchase cycle and repeat purchase rate look like? These are questions you’ll want to know the answer to when calculating CLV.
Here’s a simple customer lifetime value example from Stitch:
- Start with your customer acquisition cost: $15.
- Calculate a customer’s average order: $50.
- Estimate the repeat purchase rate at 10 percent.
The total revenue you can expect to get from each customer is your average order value, divided by one minus the repeat purchase rate, or $50 / ( 1 – 0.1) = $55.56. Subtract the customer acquisition cost from that, and you get a customer lifetime value of $40.56.
Pay Attention to the Early Signs
But what, you may ask, is the anticipated “lifetime”—the “L” in the CLV? Starbucks calculates a customer lifetime of 20 years. Your specific customer data will form an analogous projection for your company, nuanced by what you feed into the algorithm. As inspiration to marketers everywhere: Starbucks cites a repurchase or retention rate of 75 percent, at a 21.3 percent profit margin per customer.
The customer who returns again and again over the course of two decades probably set this pattern with the initial brand interactions. Learning to interpret these cues and clues are crucial for marketers, not only to ensure longevity with the specific customer, but also to flag high potential for longevity and profitability in new customers. Customers who don’t exhibit these promising early cues also become more visible, and being able to distinguish between keepers and weepers helps your team determine where to invest resources, services, time and attention.
Know When to Hold 'em, Know When to Fold 'em
As part of the work of CLV, you need to sift the wheat from the chaff so that your company can prioritize which customers to target for fastest, easiest returns.
Amy Gallo, writing for The Harvard Business Review comments:
“By comparing the CLV across customers, you can determine which are more or less profitable to you, thus segmenting your customer base. Knowing each customer’s profitability is the first step to managing them. You can then decide on where to focus your marketing, product development, customer acquisition, and retention efforts.”
The ruthlessness of the numbers, however, should be offset by realizing that a customer who has stopped interacting and purchasing should initially be viewed as an opportunity to improve your market knowledge and service. The loss of that customer’s business may hold a key to your company doing something better. Give the customer the opportunity to share whatever they wish, via a personalized email, and respond in real-time when possible. Does it cost you anything to keep inactive accounts on your books? Review and consider.
How to Add Value to Your Offering
For ecommerce, data collected in calculating CLV will include the length of time a customer spends browsing your site before purchasing or “cart abandonment” (leaving the site before making a purchase). Both of these behaviors may offer an opportunity for a creative touchpoint — for instance, a chat bubble that asks, “Having trouble making a decision today? We can help. How does a free XYZ (or free shipping, etc.) sound?”
Send a handwritten note to A-list customers to offer access to an upcoming exclusive purchase, or a new product launch. The intimacy of ink on paper, sent in an actual envelope via the USPS, makes the offer seem especially confidential, personal, and unusual. A handwritten note along the same lines may also spark new business if a customer has been inactive for more than a typical purchase cycle.
Upselling and cross-selling are time-honored ways of adding value to the relationship. Access to refined data now makes this process more exacting — by surveying customer interests, travel destinations, and leisure activities, for instance. Cross-selling at its most sophisticated means offering the customer something other than another SKU. It may mean an invitation to an event (at a museum, gallery, garden, park, historic site, restaurant, spa, health club) in their city, gleaned through a partnership or association with your business; or a discount on a product or service from another business you’re partnered with.
By scrutinizing what makes current customer relationships successful, we can also better understand what it takes to move the needle on greater potential value across all market segments.