Do you know how much one new customer is worth to your business? Do you know how much is too much to spend in order to gain one new customer? How much are your current customers worth?
Understanding Customer Lifetime Value (CLV) will help you answer these questions and more. Knowing what value you place on every customer is important when it comes to allocating marketing budgets, selecting marketing channels, determining marketing ROI and will also help with forecasting revenue.
Roughly defined, CLV is the projected revenue that a customer will generate during their lifetime. There are multiple ways to calculate CLV from technical, complex formulas to a simple review of an average customer’s acquisition and revenue costs. The most straightforward way to calculate CLV is to take the revenue you earn from a customer and subtract out the money spent on acquiring them.
A solid estimate for expected revenue from a client involves the value of a typical sale to a customer (say, $300). Multiply it by the number of times annually he or she will buy products (say, four times) and multiply that by the number of years the typical customer does business with you (say, three years).
$200 x 4 x 3 = $2,400 (lifetime revenue)
Next, calculate the amount you spend to acquire a new client for your business. Your goal is typically to spend as little as possible for a new lead, while reaching the best possible leads to increase the chance of a sale. If your $2,000 campaign brings in 200 people, you are paying $10 for each lead. If you are able to generate sales to 50 of those leads, you are paying $40 for each new customer.
$2,000 / 200 = $10 (per lead)
$2,000 / 50 = $40 (acquisition)
Using the lifetime revenue and acquisition costs above, your customer lifetime value would be $2,360.
$2,400 – $40 = 2,360 (CLV)
Strong customer service and selling skills will decrease your acquisition cost by increasing the chances of new leads turning into new customers (from 50 to 80). Strong customer service and retention marketing and programs may increase average spend (from $200-$250) and/or the length of the customer relationship (3 years to 4).
$250 x 4 x 4 = $4,000 (lifetime revenue)
$2,000 / 80 = $25 (acquisition)
$4,000 – $25 = $3,975 (CLV)
CLV is a very important metric for understanding your customers and shaping future decisions. It is more than a simple dollar value that you calculate and then set aside. It will help you to make important business decisions about sales, marketing, products, and customer service.
Marketing: How much am I willing to spend to acquire a new customer? Consider both short and long term goals. For short term cash flow, spend as little as possible to acquire new customers and see an instant boost in sales. Longer term, you may be willing to spend a bit more to acquire a well suited new customer who will provide more revenue into the future.
Product Mix: How can I offer products and services tailored for my best customers?
Customer Service: How much should I spend to maintain a good customer? What can I do to keep customers longer and earn their referrals? Remember, a happy customer is a loyal customer.
Sales: What types of customers should sales reps spend the most time on trying to acquire?
If you are looking for more detail on CLV, check out this infographic from Kissmetrics which includes a detailed case study of Starbucks.
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