What is customer lifetime value?
Also known as lifetime value or LTV, customer lifetime value refers to the predicted total revenue you will gain from a given customer over the course of their relationship with your business.
If you wish to learn more about this topic, check out the FAQ section below:
Question #1: How do I measure customer lifetime value?
If you want to measure customer lifetime value, you will need to multiply the average size of each transaction with the average number of transactions that happen per year—as expressed by the following formula:
Average Transaction Size x Number of Transactions Per Year x Retention Period = CLV
Let us see it in action:
Say you run a restaurant. If your average customer orders $15 worth of food and drinks per visit and drops by 100 times per year over the course of five years, then your customer lifetime value would be $7,500. You get this number by simply inserting the numbers into the formula above:
$15 (Average Transaction Size) x 100 (Number of Transactions Per Year) x 5 (Retention Period) = $7,500 (CLV)
You can use the exact same formula for virtually any other type of business you could think of.
If you run a gym that sells monthly memberships, then you can simply multiply your monthly membership rate by the average number of months a client typically stays a member. For example, if your monthly membership costs $50 and a typical client only stays for three months, your customer lifetime value would be $150:
$50 (Average Transaction Size) x 3 (Number of Transactions Per Year) x 1 (Retention Period) = $150 (CLV)
But what if a typical client stays a member for five years instead? Well, your customer lifetime value would be $3,000:
$50 (Average Transaction Size) x 12 (Number of Transactions Per Year) x 5 (Retention Period) = $3,000 (CLV)
The same goes for an airline company. If the average customer spends $500 per flight and flies three times a year for six years, then the customer lifetime value would be $9,000 using the same formula.
Question #2: Why is customer lifetime value important?
Customer lifetime value is important because it gives you a clear idea of just how much revenue you can generate from a typical customer, which, in turn, helps you do things such as:
- Do profit forecasting
- Accurately determine ideal customer acquisition costs
- Set clear goals for improvement
Let us take a closer look at each one.
First, customer lifetime value allows you to do profit forecasting because it gives you actual numbers to work with instead of making baseless assumptions. This, in turn, allows you to know exactly not only how much money your business is making now, but, more importantly, how much money it stands to gain if you grow your customer base, improve your average transaction size, retain each customer for longer, or do all three.
Second, it allows you to set realistic customer acquisition costs because you know how much revenue a typical customer would generate for you.
For example, if your customer lifetime value is only $200, then spending $150 on each new customer may not be the best play. Instead, you should explore more cost-effective alternatives, such as Google or Facebook ads.
In contrast, if an average customer typically generates $20,000 during the course of their relationship with your company, then you should be able to spend so much more on acquiring new customers without worries.
Question #3: How do I improve customer lifetime value?
As we have seen earlier, the formula for customer lifetime value is ‘Average Transaction Size x Number of Transactions Per Year x Retention Period’, which means if you want to improve your customer lifetime value, all you have to do is bump up any (or all) of the three variables.
But how exactly can you do that? Well, here are a couple of suggestions to help you get started:
- Run a loyalty program
- Run promotions
- Improve your customer service
- Improve your after-sales support
- Offer exceptional products and services