Why Customer Lifetime Value is Important for Your Business
What Is Customer Lifetime Value?
Customer lifetime value is one of the most important metrics a business can track. It tells you a huge amount about your businesses’ viability, its relationship with its target market, its competitiveness, and what it can spend on marketing.
In a nutshell: customer lifetime value tells you how much your average customer will spend over the entire course of their relationship with your business.
It’s something you can track over time, to see how it improves (or declines) after product changes, launches in new markets, or changes to the marketing mix.
Why Is Customer Lifetime Value Important?
Customer lifetime value is such an important metric because it provides an easy-to-calculate and read measurement of a lot of different business health indicators.
1) Your bottom line/profitability
Your customer lifetime essentially tells you if it is worth your while making and shipping your product. If it doesn’t exceed the costs to manufacture, market and deliver your product then your business either needs to drastically change or it will not succeed.
2) Your ability to grow
Acquiring new customers costs money – your business will have a customer acquisition cost (CAC) While you can reduce that cost with better marketing decisions, it’ll never be zero. Your average lifetime value will tell you what you can afford to spend on marketing – ideally, your customer lifetime value should be around 3x your CAC. Depending on the market, a typical CAC could range from $9 to $900 depending on the product and market. So if your customer lifetime value is lower than your CAC, or does exceed it by enough, you may not be able to afford to acquire new customers and your business could be doomed to stagnate or fail. Your LTV/CAC ratio is a core part of calculating a marketing budget.
3) The effectiveness of your pricing/product strategy
By tracking your customer lifetime value over time you can accrue valuable learnings about your pricing and product strategy. If you increase your prices and your customer lifetime value also increases, without reducing the number of orders by much, you’ve learned something about the price elasticity of your model. If you launch new products and your customer lifetime value goes up thanks to cross and up-sells, you can tell that those new product launches were effective.
4) Your potential ideal target audiences
By doing cohort analysis of your customer lifetime value you can identify particularly valuable segments based on how much they spend. If those segments are targetable, and their associated acquisition costs make sense, it may be worth devoting more of the marketing budget towards reaching them. Although it’s worth being careful of not falling into the trap of always chasing the highest-value customers only. Most brand growth comes from low-value customers.
5) Your product/market fit
A high customer lifetime value tells you you’re on to something. It tells you that your product/products/brand is something people are willing to pay for. It indicates that they were happy enough with the product or service they received that they were willing to come back and buy more.
6) Your brand loyalty
A high customer lifetime value, especially when compared to your average order value, tells you that your target audience like you. If they come back and buy the same product again, or a different product, or they maintain their subscription for a long time, it indicates that you have earned their loyalty.
What Is The Difference Between Lifetime Customer Value and Average Order Value?
It’s important not to get confused between lifetime customer value and average order value. They are related, but not the same.
Average order value = the average value of an individual order from a customer. It’s highly important, and worth tracking and trying to improve, but tells you nothing about longer term cross or up-sell efforts or brand loyalty.
Lifetime customer value = the amount a customer spends over their lifetime, including repeat purchases and purchase of different products.
You need to track both, and understand what both tell you.
How Do You Calculate Lifetime Customer Value?
We have covered calculating lifetime customer value before. But here’s a quick summary below:
Some businesses use a profit-based calculation, others use a revenue-based calculation. For this example we’re going to use a revenue-based calculation for historic customer lifetime value.
In essence, the steps are the following – but it does vary by the business type. Eg for subscription businesses, it’s a different calculation.
1) Find your average purchase (or order) value. This is the total revenue in a given period divided by the number of orders received. The given period should be long enough to more than encompass the average sales cycle for your business.
2) Work out your average purchase frequency. This is the number of purchases divided by the number of customers who purchased in the given period.
3) Calculate average customer value (ACV) for the given period – which is 1) multiplied by 2).
Next you need to add the ‘lifetime’ part of the equation. You multiply the ACV in the given period (say 6 months) by the average time a customer stays with you. So if a customer typically stays with you for 2 years you multiply your ACV by 4 (if the given period was 6 months).
This is an example calculation: it does vary significantly depending on the business model. And if you’re a startup, you may not be equipped with all the information to calculate it in this way (for example you may not know how long your customers typically stay with you. In which case you’ll need to make an estimate based on industry data.
How do You Increase Customer Lifetime Value?
Once you know your customer lifetime value you’re going to want to try to increase it. There are plenty of ways to do it – here are some initial ideas:
Implement good customer relationship management (CRM) practices
CRM is a core part of improving customer lifetime value. With a CRM software set up such as Active Campaign or HubSpot, you can divide your customer base into segments and send them regular emails with product launches with are relevant to them, or special offers, or targeted messaging to encourage a repeat purchase, cross-sale or up-sale.
Improve your audience targeting with segmentation
By working out your customer lifetime value across different cohorts you can begin to discover where your most valuable customers are. By increasing your marketing and promotions to them you can increase your overall average customer lifetime value.
Improve your product
The most reliable way to drive brand loyalty and repeat purchases is to give your customers a great experience. By giving them what they want, at every point during their experience from initial research to delivery, you’ll encourage them to build positive memories around your brand. The next time they hear your name, or need a product like yours, they’ll be far more likely to return.
Improve your customer journey
If the experience of buying from you is incredible easy and fast, customers are far more likely to buy again. This was the attitude of Amazon and was a huge part of their success. Make it quick and easy for a customer to do what they want and they’ll likely turn to you again out of pure convenience, increasing your customer lifetime value.
Adjust your pricing
You’ll need to be careful when doing it, but pricing can have a huge impact on lifetime customer value. A price cut may drive short term sales, but it can reduce customer lifetime value over the long run. A price increase may reduce short term sales, but could increase customer lifetime value over the long run – so long as it’s carefully done. Experiment with price changes + targeted offers and see how it affects conversion and re-order rates. Be careful not to rely too heavily on price promotions and discount codes – you can end up simply giving people discounts to make a purchase they would have made anyway.
Growth Division’s Verdict
Customer lifetime value is one of the most important metrics a business can track. It tells you a lot about the health of the model, your marketing performance and your competitiveness. By tracking it over time, and constantly experimenting with ways to improve it, you can grow your market share just as you could by experimenting with acquisition approaches.
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