The MOST important marketing metric - CLV

Real-world examples and a free calculator to help you understand CLV and its impact on your business.

Before you spend time and money on Adwords, Facebook ads or other more costly acquisition techniques, how do you know how much you should spend? How much is that click really worth? Do you know who your most valuable customers are? What makes them different from your average customer?

The secret lies in 3 words: Customer Lifetime Value - aka CLV. Generally speaking, CLV is the projected revenue a customer will generate for you during their lifetime through repeat purchases.

Access your Free CLV Calculator and ROI tool
Subscribe to: CLV Tool

Why CLV is such an important metric

I had a client spend a tremendous amount of money and effort on PR and was absolutely delighted when a few prominent blogs mentioned their products in gifting guides for Mother's Day. They were even more thrilled when they saw a spike in traffic and orders coming from these blogs. The conversion rate for these visitors was much higher than the average site visitor. Clearly, all that time, money and effort was worth it, right? Well, not so fast. Those customers were buying the lowest priced items on the site. Additionally, since most were buying gifts, the likelihood that they will return to make additional purchases is low. It turns out, that traffic from these sites was fairly low quality - they had a very low customer lifetime value - around $33. To put this into perspective, their CLV for customers coming from organic search is $871! Which customer would you rather invest in?

When you combine CLV with other metrics like your Customer Acquisition Cost, you can calculate your return on investment, allowing you to make better decisions about your marketing strategies.

Additionally, knowing who your most valuable customers are will give you great insight into who you should be targeting. It can also let you focus your retention efforts on those most likely to be loyal.

Not all customers are should be created equal

As we saw in the example above, not all customers have the same value. By creating segments, we can calculate CLV to uncover your best customers (and effectively target new ones) or; you may want to know if customers acquired through Facebook ads are more or less valuable than Google AdWords and whether you are spending the right amount in each of those channels. Or, you may want to segment by product category or even by landing page.

In the case study below, I will show you how we created a customer segmentation of the BEST, TOP and AVG customers for the fictional company, Kitchen Gal. By calculating the CLV for each segment, we learned that the top 2% of customers (our BEST) accounts for 20% of annual revenue and will spend 26x more than the average customer over their lifetime. That’s pretty amazing! And it's not an anomaly.

The top 1% of e-commerce customers spend 30x more than the average customer. The lifetime value of these customers isn’t just a little better; it’s dramatically better3.

What to do with your CLV

Ok, if you’ve stuck with me this long, this is where it gets exciting! Knowing your CLV will inform your marketing strategy in a number of ways. Here are just a few things you can do with CLV.

1. Improve customer retention

Your BEST customers are worth 30x more than the average customer. Now you know who they are and can make sure you treat them like the VIPs they are. Learn from their profiles and see how you can apply those learnings to increase the CLV of your TOP customers.

A 5% increase in customer retention can increase profits by 25% to 95%. It costs 6-7 times more to gain a new customer than to keep an existing one.

2. Improve your targeting and message

Make a profile of your BEST customers. In the case of Kitchen Gal, there are just 33 of them; a pretty manageable number to do some in-depth research on. What do they have in common? Are there demographics they share? How did they first find out about your store? Armed with a clear profile, you can fine-tune your marketing message, channels, and audience targeting. You can create Facebook look-a-like audiences based on your BEST profile.

3. Calculate ROI

ROI essentially measures the return on investment from the amount spent on marketing. Your ROI can help justify your spend and demonstrate what to spend on.

The difference between your CLV and your Customer Acquisition Cost is your return on investment (ROI).

Your Customer Acquisition Cost (CAC) (the amount of money you spend on sales and marketing to gain a new customer) is calculated by taking your entire marketing budget for a specific timeframe or campaign and divide by the number of new customers you gained in that same period. Use the free calculator to see your CAC.

Another way to look at it is to evaluate your CLV:CAC ratio. The ratio demonstrates how much revenue you gain from your customer vis-à-vis how much you spend to get the customer. In the case of Kitchen Gal, the CLV:CAC for their BEST customers is 13:1 and 27:1 for the AVERAGE customers. Both these ratios are rather high, which means Kitchen Gal is getting a lot from her sales and marketing efforts. Obviously, you want your Customer Lifetime Value to be higher than Customer Acquisition Cost and the closer you get to 1:1 means that you are not getting a very good return on your investment. With such a high CLV:CAC, I might recommend that Kitchen Gal put more investment into efforts to reach and acquire new customers.

4. Know how much to spend

We now know that we can spend quite a bit to acquire a customer in the BEST segment, but much less for the TOP and AVG. Your BEST customers may cost more to acquire, but they will likely be more profitable.

Take your CLV and the conversion rate for your campaign. For Kitchen Gal, the CLV for our AVERAGE customer is $214 and our avg conversion rate is 2.5%. So, our break-even would be $157 * 2.5% or $3.93 per click. As long as we spend less than $3.93 per click, we will make a profit. However, if we target our prospects that fit our BEST profile, we can pay up to $137 per click!

How to calculate Customer Lifetime Value

I have created a nifty little calculator for you so that you can simply drop in your numbers and watch your CLV magically appear! However, if you'd like to understand the logic behind it, read-on.

First, we need to calculate your Average Customer Value (ACV). ACV is the average a customer will spend in a given period. You will need two numbers for the equation.

1. Average Order Value (AOV) - The average value of a single transaction.

Net Revenue
= Average Order Value
Number of Orders

2. Purchase Frequency (PF) - How often the customer is likely to purchase in a given period.

Number of Orders
= Purchase Frequency
Number of Unique Customers

Average Customer Value (ACV)

Now you can calculate your average customer value. To calculate ACV, simply multiple AOV × PF. The obvious difference between this number and your CLV is the "Lifetime" part. By taking the long term view and accounting for customer loyalty, we will have a better understanding of a customer's value over time.

Now for the final equation:

Avg. Customer Value
×
Avg. Customer Lifespan*
= Customer Lifetime Value

* Average Customer lifespan represents the number of years that a customer will likely continue to buy from you. For many businesses, this may require a bit of educated guesswork, particularly if you have not been in business for long.

I've created a tool to do the match for you. Simply plug in your numbers and get your CLV.

Access your Free CLV Calculator and ROI tool
Subscribe to: CLV Tool

How to create customer segments to identify your BEST customers

Kitchen Gal has an online store with over 250 products with a range of prices from $10 to $1,800. They'd like a better sense of who their best customers are and how to reach more like them. 

The first thing I do is export all the customers who have purchased in the last year (your CRM or E-commerce platform can likely perform this for you). I set up a spreadsheet that included Customer Name, Net Revenue in the past year, Number of Orders, Date of most recent purchase. You can see an example of this spreadsheet in the free CLV download.

I rank each customer on a scale of 1-3, with 1 being the lowest and 3 being the highest, for Recency, Frequency and Value (RFV) to determine a score for each customer. I love RFV because it is focused entirely on the customer and their behaviors.

  • Recency is the number of months since a customer made a purchase. Because a customer who purchased recently is more likely to purchase again, customers who purchased within the last three months are assigned a 3, three to six months a 2 and more than six months ago a 1. You can determine what breakdown makes the most sense for your business.
  • Frequency is the number of orders placed in a given period of time. A customer becomes increasingly more likely to buy again as the number of purchases increases. Since most of Kitchen Gals’ customers only purchase 1-2 times per year, I assigned a score 1 to one order, 2 for two-three orders and a 3 for four and above.
    After one purchase, a customer has a 27% chance of returning to your store. After a 3rd purchase, they have a 54% chance of purchasing again1.
  • Value is the monetary value that each customer has spent. Some customers spent $12 last year while one spent over $12,000. That’s a broad range, but the majority of orders were $300 or less.
    "There’s a direct relationship between how much a customer spends on their first purchase and the likelihood of repeat business. Those spending the most on first-time purchases were almost 2x as likely to return as those spending the least.2"

Once you have ranked all the customers for RFV, you sum up the numbers for your RFV score. Now you can sort your chart by RFV score and see your customers ranked. I further divided the results into 3 categories for my BEST, TOP and AVERAGE Customers (color coded in the chart).

spreadsheet example of RFV scoreDownload the spreadsheet

Now that you have your three segments, you can calculate your magic numbers for each. The top 2% of customers (our BEST) accounts for 20% of annual revenue and will spend 26x more than the average customer over their lifetime. That’s pretty amazing! And it's not an anomaly.

The top 1% of e-commerce customers spend 30x more than the average customer. The lifetime value of these customers isn’t just a little better; it’s dramatically better3.
CLV calculator

If you only looked at the revenue generated from each segment, you might think that the AVERAGE customer is most important to your bottom line. But, look at the CLV. Ten customers in Kitchen Gal’s BEST category are worth over $73,000. You would have to acquire 257 AVERAGE customers to generate the same amount. Not only that, but you will have to keep acquiring those AVERAGE customers because they are much less likely to purchase from you again. It costs more time, money and energy to acquire new customers than to keep existing customers. What a waste!

Conclusion

Understanding and calculating CLV can be a bit tricky at first, but it can save you tons of wasted effort and money. You can make spending decisions with confidence knowing that you are targeting the right customers. If you have questions, or if any of this was overwhelming, propp +co can help! We specialize in making this process simple for your business, so please reach out.

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