Customer Lifetime Value is often known as CLV. In simplest terms, it is the value a specific customer contributes to a business throughout their lifetime. You start to calculate the Customer Lifetime Value along with the first purchase, subscription, or contract of a new customer. It ends whenever the subscription or the contract terminates – commonly known as the “moment of churn”.
Calculating Customer Lifetime Value
Well, every business owner can realize how important CLV for their growth. Likewise, it is also important to know how to calculate the same. Well, you should look at several important aspects when calculating the CLV. For instance, the lifespan of the customer, the customer churn rate, retention rate as well as the average profit margins per customer should be considered.
Nevertheless, there are a couple of different methods used to calculate CLV. Also, there are predictive CLV calculations or historic CLV calculations. The type of the calculated CLV depends majorly on the data you input into the formula.
The term historic CLV is the number that represents all the profits gained from the past purchases of a given customer. This is calculated using the existing data related to a particular period.
This is the calculation that helps you predict the amount a particular customer will contribute to the profit of your business during his or her contract, subscription, or relationship. This is a relatively more complete strategy to assess CLV.
When it comes to the predictive method, it considers the transaction history as well as the behavioral patterns to calculate the respective customer’s current value. Then, the same data will help you predict the growth of the customer value over time. Well, the more data you include in this strategy, the more accurate the value of the calculation.
A Simple Formula to Calculate Customer Lifetime Value
Let’s take a look at the most basic method to calculate CLV. First, multiply the annual revenue of a customer by the average lifespan of a customer. Then, deduct the initial cost you have to bear to acquire them.
(Annual Revenue of The Customer X Average Lifespan of Customer Relationship) – Expenses for Customer Acquisition.
You can make use of this method to budgets allocated to marketing and sales campaigns to acquire new customers.
An important thing to consider is that this formula works perfectly if the annual profit contribution of a customer is pretty predictable and consistent.
The traditional method to calculate the CLV formula
If you don’t have a flat or consistent annual sale per customer, you will require a pretty comprehensive formula to do it.
This is a pretty detailed formula that includes annual individual costs as well as the annual profits. Mentioned below are the numbers you should know to calculate CLV using the traditional method.
- Customer lifespan’s average gross margin
- Retention rate
- Discount rates offered (if any)
Gross Margin X [Customer Retention Rate / (1+ Discount Rates – Retention Rate)].
As per this method, you can calculate the potential fluctuations related to customer revenue during the given period. However, if you are not 100% sure about the discount rates, you can apply a 10% general rate on it.
You need to calculate CLV to boost customer retention. There’s about a 20% probability of selling to a new customer. However, when it comes to selling an existing customer, the probability is around 70%. So, the majority of your business’s revenue comes from existing customers. You can use the above methods and calculate the contribution of your customers and then implement strategies to increase customer retention.