Customer Lifetime Value (CLV) is a way to measure how much money a customer is likely to spend at your business over time. It helps you understand how valuable a customer is, not just after one purchase, but over their whole relationship with your company. Knowing this number can help you make smart decisions about how much to spend to get new customers and how to keep the ones you have.
Why Is CLV Important?
CLV is important because it helps businesses figure out how much to invest in getting and keeping customers. For example, if you know a customer will spend $500 with you over several years, you might decide it’s worth spending $50 to get them to make that first purchase. CLV also helps you see which customers are most valuable, so you can focus on keeping them happy.
How to Calculate CLV: The Simple Calculation without Churn
To calculate CLV, you need three numbers:
- Average Order Value (AOV): How much a customer usually spends each time they buy something.
- Purchase Frequency (PF): How often a customer makes a purchase.
- Customer Lifespan (CL): How long a customer keeps buying from your business.
The formula is simple:
CLV = AOV × PF × CL
For example, if customers spend $50 each time they shop, buy from you 4 times a year, and stay with you for 3 years, their CLV would be $50 × 4 × 3 = $600
Adding Customer Churn to Calculate a More Accurate CLV
Customer Lifetime Value (CLV) is a key metric that tells you how much a customer is worth over the time they do business with you. But to make this calculation even more accurate, you need to consider customer churn. Churn is the rate at which customers stop doing business with you. By including churn in your CLV calculation, you can get a clearer picture of how long customers stay and how much value they bring.
Understanding Customer Churn
Churn is the percentage of customers who leave or stop buying from you over a specific period. For example, if you have 100 customers at the start of the month and 10 leave by the end, your churn rate for that month is 10%. High churn rates can seriously lower your CLV because fewer customers stick around long enough to make repeat purchases.
The Adjusted CLV Formula
To include churn in your CLV calculation, the formula changes slightly. The basic formula for CLV is:
CLV = AOV × PF × CL
But when you add churn, it looks like this:
CLV = (AOV × PF) / Churn Rate
Here’s how it works:
- Average Order Value (AOV): This is still how much customers spend on average each time they buy.
- Purchase Frequency (PF): This is how often they buy.
- Churn Rate: This is the percentage of customers who leave during a specific period.
By dividing the product of AOV and PF by the churn rate, you account for the fact that not all customers will stick around forever. This adjusted formula gives you a more realistic view of how much revenue you can expect from each customer before they stop buying.
Why This Matters
Adding churn to your CLV calculation is important because it reflects real customer behavior. Businesses with high churn rates will see lower CLV, which means they need to work harder to retain customers or attract new ones. On the other hand, a low churn rate means customers are sticking around longer, increasing their lifetime value. This makes your marketing efforts more efficient because you’re getting more value from each customer.
Example Calculation
Let’s say your AOV is $50, your customers buy four times a year, and your churn rate is 20% (0.20). The formula would look like this:
CLV = ($50 × 4) / 0.20 = $200 / 0.20 = $1,000
This means the average customer is worth $1,000 over their lifetime with your business. If you hadn’t included churn, you might have overestimated this value.
CLV and Customer Acquisition Cost (CAC)
CLV is also useful when compared to Customer Acquisition Cost (CAC), which is how much you spend to get a new customer. If your CLV is three times higher than your CAC, that’s a good sign. It means you’re making three dollars for every dollar you spend to get a customer. If your CLV isn’t much higher than your CAC, you might need to change how you attract or keep customers.
How to Improve CLV
Here are some ways to increase CLV:
- Loyalty Programs: Encourage customers to keep coming back by offering rewards.
- Upselling and Cross-Selling: Suggest related products or upgrades to what they’re already buying.
- Great Customer Service: Make sure your customers are happy so they keep coming back