Customer lifetime value (CLV) is an important business metric that helps you determine the profitability of a customer and effectively allocate available marketing, sales, and production resources. To help you do this, we'll take a closer look at CLV in this article. Among other things, we'll tell you how to calculate the Customer Lifetime Value and 5 measures to optimize it. But let's start from the beginning: What exactly is CLV?
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- What is customer lifetime value (CLV)?
- How do you calculate the lifetime value of a customer?
- What is customer lifetime value? - A simplified example
- CLV: The advantages and disadvantages of customer lifetime value
- Increase Customer Lifetime Value: These 5 methods make it happen
- Frequently asked questions about CLV
What is customer lifetime value (CLV)?
Customer lifetime value (CLV) is a key performance indicator from the field of business administration. As a rule, it describes the contribution margin that a customer generates over his entire customer life cycle, discounted to the point in time under consideration. The CLV can therefore be understood as the average value that customers have had for the company over the years or that they will have in the future. Therefore, in addition to past revenues, expected future revenues are also taken into account. When determining customer lifetime value, it is important to separate potential customer value from actual customer value. Potential customer value takes into account a customer's total spend, including competitors' spend in a particular area, while actual CLV only takes into account the customer's own company spend. Companies use CLV to more effectively tailor marketing to their customers. For example, a higher CLV may justify a higher budget for servicing a particular customer.
READING TIP: Learn possible reasons for customer churn and 5 actions to win back lost customers.
How do you calculate the lifetime value of a customer?
You can easily calculate the Customer Lifetime Value in just two steps:You can easily calculate the Customer Lifetime Value in just two steps:
1. record characteristic values:
T is the duration of the business relationship.
eT is the expected deposit of an individual customer.
aT is the costs incurred in maintaining the customer.
i is the calculation interest rate, which uses the duration of the entire customer relationship as the calculation variable. Here, the average over the entire customer term is often used.
In other models, aspects such as sociodemographic factors (income, social environment or other reference variables) or data provided by the customer can be included in the calculations as meaningful values.
2. calculate CLV: A general formula for calculating CLV:
CLV = (eT – aT) ÷ ((1 + i) × T)
What is customer lifetime value? - A simplified example
Suppose you want to calculate the CLV of the customer of a mobile phone provider. The term of the business relationship T is set to 10 years. Therefore, the calculation interest rate is 10%, which is used in the formula 0.1. Every two years, customers buy a new smartphone worth €400 (eT). The manufacturer spends €50 (aT) per year on customer service in the form of correspondence, phone calls and e-mails. Since eT and aT are values that must be related to the duration of the customer's existence, the following is calculated in advance: 5 × 400 = EUR 2000, 50 × 10 = EUR 500. Now put the value into the CLV formula:
CLV = (2000 – 500) ÷ ((1 + 0,1) × 10)
CLV = 136,36
The customer's CLV is thus 136.36 euros per year. Optionally, further aspects can be included here. For example, if a customer has recruited another, this new customer can be included in the calculation. The resale rate or cross-sellings can also be used. Accordingly, there are various models for calculating the Customer Lifetime Value.
READING TIP: How to test and optimize your website speed to increase customer satisfaction and CLV, among other things, we reveal here.
CLV: The advantages and disadvantages of customer lifetime value
Now that we know how Customer Lifetime Value is calculated, let's take a look at the benefits of knowing this value for your business. After that, we will also look at the weaknesses of the CLV.
Advantages of the CLV
1. increasing CLV can increase sales over time.
The longer the life cycle or the more value the customer brings into this life cycle, the more revenue the company generates. Measures to optimize the CLV, e.g. cross-selling or upselling, therefore lead to higher sales.
2. CLV can help identify problems and thereby increase customer loyalty.
By prioritizing CLV in your organization, you can identify worrying trends and take action to correct them. For example, if you find that your CLV is consistently low, you can optimize your customer service strategy or loyalty program to better meet your customers' needs.
3. it helps you to target the optimal customers.
If you know your customer's lifetime value, you'll also know how much they spend with your company over time - so whether it's 50, 500 or 5,000 euros, for example. With this knowledge, you can develop a customer acquisition strategy that targets the customers who buy the most from your company.
4. increasing CLV can help reduce the cost of customer acquisition.
Statistics show how important it is for companies to identify the most valuable customers and nurture the customer relationship. This way, you can achieve higher profit margins, higher customer lifetime value and lower customer acquisition costs.
READING TIP: Conversion rate optimization is another key factor for sustainable business success.
Disadvantages of the CLV
However, the CLV also has its weaknesses. In particular, the sales expected in the future are an estimate. They could turn out to be considerably smaller than assumed or even fail to materialize at all. In addition, it requires a usable database to calculate the CLV. In e-commerce in particular, it can be difficult, for example, to assign all transactions to a singular customer in order to achieve a usable database for the CLV while at the same time complying with privacy and data protection.
Increase Customer Lifetime Value: These 5 methods make it happen
You now know what CLV is, how important it is to know it, and how you can calculate it. Now it's time to demonstrate methods you can use to increase your Customer Lifetime Value.
1. improve onboarding process
The onboarding process is the period of time during which you introduce your customers to your brand and products, slowly building trust and a relationship. By optimizing this process, you can create a framework for long-term customer relationships and, over time, increase your CLV.
2. increase AOV
The AOV is the average order value. If this is increased, the customer lifetime value can of course also be improved. This can be achieved, for example, by offering relevant additional products to the products the customer is about to buy (cross-selling). Even if it's just a low-cost additional product, this method can add up and increase revenue and CLV over time.
READING TIP: Here we present 11 ways to increase AOV with Shopify Plus.
3. maintain customer relationships
If you build a real relationship with your customers and maintain it for the long term, this will increase their satisfaction, they will buy from you again and again, and you can significantly increase the CLV of these buyers. To improve the relationship with your customers, you can take various measures. First of all, it is important to establish a continuous connection. After all, the easier it is for your clientele to get in touch with your brand, the more trustworthy they seem and the more connected buyers feel with your company. Of course, a continuous connection is closely related to good customer service. However, you should not only be easily accessible, but also create other positive experiences for your customers in terms of support. This can include good return policies, for example, as this will make your buyers feel that quality and satisfaction are priorities for you and that you are not just concerned with sales. The result: a satisfied customer experience means a higher CLV in many cases. Who can give you more informed suggestions for improvement and feedback on your products than your clientele? That's right: no one. They use your products or services, which is why your buyers' opinions should matter to you. So take advice from your customers. This can not only optimize your products, but also foster long-term loyalty among your customers, thereby increasing CLV.
4. introduce loyalty programs
Loyalty programs are another effective way to increase CLV. Various benefits and special offers result in your clientele becoming more loyal to your brand. Loyal customers are not only more likely to purchase from your business themselves, but they are also more likely to recommend it to friends and colleagues. For this reason, you should consider such a program and, if possible, always offer added value to your buyers.
READING TIP: We explain how a loyalty points program in online stores works, for example, in this blog post.
5. increase product quality
While customer relationships should play an important role in any business, don't forget the importance of product quality. Problems or inferior products can have a big impact on your CLV. This, of course, can quickly affect the brand's reputation. Therefore, ensuring good product quality is a necessary condition for the sustainable development and growth of the company.
As we have now established, calculating CLV is often very good for business. Understanding the value of a "customer life" can help the marketing and sales department in particular to allocate marketing budgets appropriately or reactivate customers at risk of inactivity. Separating profitable customers from unprofitable ones also prevents bad investments and creates the conditions for sustainable customer relationships. Even though you should know and understand the CLV calculation formula, you may still rely on reporting tools and a modern CRM for implementation.
Frequently asked questions about CLV
What is the Customer Lifetime Value (CLV)?
Customer lifetime value (CLV) is a key figure that provides information about the contribution margin that a customer realizes in a company over the course of its entire customer life cycle. CLV is made up of historical and future potential customer value.
How is the CLV calculated?
There are various options for calculating customer lifetime value, depending on the company's objective. A simple formula is as follows:
CLV = (Expected deposit from customer - Cost of customer care) ÷ (1 + Calculation interest rate) × Duration of business relationship.
In the article we explain the composition of this formula in more detail and provide an example for better understanding.
What are the advantages of the CLV?
Customer Lifetime Value can reveal many important business drivers to make more informed decisions. For example, using CLV, you can:
Identify the overall customer profitability to create the optimal Customer Acquisition Cost.
Identify user profitability over time to give greater weight to time to value.
Assign a CLV to each acquisition channel to drive higher ROI for paid channels.
Promote the most profitable offers by breaking it down by product or plan.
How can I increase the CLV?
In this article, we present 5 ways you can increase your CLV. For example, you could strengthen your customer relationships or introduce a loyalty program. You can learn more in the corresponding chapter here in the blog post.