Gaining and losing customers over a period of time, is a part of business, yet companies with great engaging strategies for their products or services can hold their customers for a long time. The customer relationship is a key element that adds value to the customer over the span of time. In this blog you will be knowing all about customer lifetime value calculation.
The customer lifetime value (CLTV) is a prominent metric to measure any growing organization. By measuring the CLTV with the cost of CAC (customer acquisition cost), organizations can determine how long it takes to get back the revenue invested in acquiring the new customer which includes the cost of marketing and sales.
This blog highlights the effective way to calculate customer lifetime value.
Customer Lifetime Value is also referred to as LTV, which is the profit margin that an organization expects to earn over the whole of its business association with the customer. The CLV usually accounts for the ongoing sales and marketing expenses, operating expenses, customer acquisition costs (CAC), and the manufacturing cost (if the business is related to manufacturing products and selling).
Lifetime Value (LTV) = Average sales value * Number of transactions * Retention time period
Customer Lifetime Value – LTV * Profit margin
However, not all the companies give the whole focus on the CLV, some businesses overlook these incredible metrics and rather keep optimizing the single sale. Certainly, a brand’s growth is based on the growth of its customer base, but it is equally important to optimize the strategies for the lifetime value of existing customers for a more sustainable business model.
With respect to the calculation of the customer lifetime value – five factors need to be considered.
Calculate average purchase value: The value can be calculated by dividing the organization’s total revenue in a certain time period by the number of sales in the specified time frame.
Calculate the average purchase frequency rate: The value can be calculated by dividing the number of sales by the number of customers (unique) who made purchases in the specified time frame.
Calculate customer value: The value can be calculated by multiplying the average sale value by the average sale frequency rate.
Calculate average customer lifespan: Calculate the average of the number of years a user continues to purchase from the brand.
Calculate CLTV: Calculate the CLTV by multiplying the average customer lifespan by customer value. This will help you to determine the cost you can expect from an average customer to fetch for the company the particular time frame the customer stays in a relationship with your company.
Below is an example to determine the customer lifetime value based on the five factors:
1. Calculate the APV (average purchase value)
Average Purchase Value (APV) = Total revenue / Number of Orders
As a first step, we should measure the average purchase value of a customer. The value can be calculated by averaging the cost spent by the consumer in each visit during a whole week or a month.
For instance, let’s consider that a consumer spends about $5.90 on their every visit. Customer A visits the store 3 times a week and spends 9$ on the whole, so the average purchase value is 3$.
2. Calculate the average purchase frequency rate.
The second step is to calculate the CLTC to determine the average purchase frequency rate. In the above-mentioned instance, we should first determine how many visits Customer A made to all the store branches for the whole week. Consider an average customer visits 13 and makes 3 purchases.
The average is 4.
This can be calculated with the below formula
Average purchase frequency rate (APFR) = Number of purchases / Number of Customers
3. Calculate the average customer’s value.
Customer Value (CV) = Average Purchase Value / Average Purchase Frequency rate
From the first 2 derivations, we get to know the average spends of customers and their number of visits. Now, we should determine the average customer value, for which we should consider all the customers individually and multiply with the average purchase amount by their average purchase frequency rate.
Customer 1 = 200/2= 100
Customer 2 = 400/2 = 200
Customer 3 – 100/ 4 = 25
The average of these values gives 100.8
4. Calculate the average customer’s lifetime span.
If we were to calculate a brand’s average customer lifespan then we should look at the number of years every customer frequented with the brand. Then we can average the values together to get the desired rate.
For instance, let’s consider 3 customers and the sum is 9 ((A)3+(B)4+(C)2)
Average Customer Lifespan = Sum of Customer Life spans / Number of Customers
= 9/3 =3
5. Calculate your customer’s lifetime value.
Once we have calculated average customer value and the average customer lifespan, then this value can be utilized to calculate CLTV. To achieve this, we should first multiply the average customer value by Average customer lifespan. Customer lifetime value = Customer value * Average customer lifespan
LTV = 100*3 = 300
As described above, the given steps will enable you to measure your CLTV with the cost of CAC (customer acquisition cost) and help determine the cycle to get back the revenue invested in acquiring the new customer. Use these techniques to improve and optimize your Customer Acquisition Cost (CAC).
This was all about customer lifetime value calculation.