Customer Lifetime Value (CLV)
Definition
Customer Lifetime Value (CLV), also referred to as CLTV or LTV, is an estimation of the total revenue a business can expect to earn from the average customer throughout their entire relationship with the company. In other words: it shows how much a single customer is worth to your business. Whereas the Average Contract Value (ACV) looks at the annual revenue per client, CLV can cover more than 10 years. It's crucial for long-term growth planning and for maximizing profitability.
Importance of Customer Lifetime Value
Understanding CLV is essential for businesses because it provides an estimate of your revenue potential in the long run and it's a good indicator for how much you might invest in customer acquisition. Here’s why CLV matters:
Revenue Growth: CLV shines a light on the potential future revenue from existing customers, advocating for the long-term impact of retention versus acquisition.
Customer Acquisition Cost (CAC): By knowing how much a customer is worth to you over the entire relationship, you can allocate appropriate funds to your go-to-market team.
Customer Retention: CLV helps you identify customers with the biggest earning potential, bringing focus to your sales team.
Profitability Analysis: By comparing CLV with CAC, you can start to determine whether you're operating a financially viable business over the long-term.
Investor Attraction: A growing CLV signals you are improving your ability to create and capture value, making the business more attractive to investors, founders, and other stakeholders.
How to Calculate Customer Lifetime Value
There are several ways to calculate CLV depending on the level of sophistication and available data. Below are two common methods:
1. Basic Formula
The simplest way to calculate CLV is:
CLV = Average Purchase Value x Average Number of Purchases x Average Customer Lifespan
Example:
A B2C SaaS product has:
An average purchase value of $15.
Customers automatically renew their contracts 11 more times per year.
The average customer lifespan is two years.
The CLV would be:
CLV = $15 x 12 x 2 = $360 | This means the lifetime value of each customer is $360.
2. Advanced Formula
For more precision, especially in subscription-based models, you can use this formula:
CLV = (ARPU x Gross Margin) / Customer Churn Rate
Where:
Gross Margin = Net sales revenue minus cost of goods sold.
Customer Churn Rate = Percentage of customers lost during a specific period.
Example:
If ARPU is $15/month, the gross margin is 70%, and the monthly customer churn rate is 5%:
CLV = (15 x 0.7) / 0.05 = $210 | The lifetime value of each customer would be $210.
Applications of Customer Lifetime Value
CLV has numerous applications across business functions, here are just a few examples:
Go-To-Market Optimization: Helps allocate budgets by focusing on the most profitable customer segments.
Retention Strategies: Your team will intuitively gravitate towards retention efforts to retain the most profitable customer segments.
Pricing Strategy: CLV should be the single most important metric when refining your pricing strategy.
Product Roadmap: Helps you identify which features or products drive the most value for customers and what further development to prioritize.
Challenges in Measuring CLV
Some challenges you might experience while calculation CLV:
Data Hygiene: Incomplete or inaccurate customer data can lead to unreliable output.
Customer Segmentation: Different customer segments may have different lifespans and purchase behaviors. Avoid overly generalized analyses.
Churn Variability: High churn rates from non-ideal customer profiles (ICPs) can distort CLV predictions, especially in early-stage ventures.
CLV vs Related Metrics
CLV often works alongside other metrics like CAC and Net Revenue Retention (NRR):
CAC vs CLV: Comparing CAC to CLV ensures that acquisition costs are justified by long-term revenue potential.
NRR vs CLV: While NRR focuses on revenue retention from existing customers, CLV takes a broader view by including all potential revenue over the relationship duration.
Conclusion: Why Is CLV Important?
Customer Lifetime Value is the metric that will put a value on your customer relationships. From this starting point, companies can focus their go-to-market efforts, improve retention campaigns, allocate overall resources, and drive sustainable growth. When combining CLV with Customer Acquisition Cost, you'll find out whether you're on track to building a profitable and sustainable business.
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