How to Calculate Your Customer Lifetime Value
Figure out how to calculate your Customer Lifetime Value to help determine what your customers are costing your business.
As a small business owner you know it’s crucial it is to understand what your customers are costing you. After all, your customers will add different value(s) to your business over the lifetime of their relationship with you. For instance, your existing loyal customers likely cost much less than those potential customers who aren’t hooked on your brand yet.
So, how do you determine your customers’ worth? Well, that can often seem like a daunting task. That’s where the Customer Lifetime Value (CLV) comes into play.
CLV is a metric you can use to look at how much it’s costing you to acquire versus retain customers. Essentially, this formula helps you see which customers are most profitable to your business and allows you to calculate the value of each group, whether it’s your entire customer base, a segmented group of customers, or even an individual customer. Knowing this information can help you tailor your marketing efforts to be more effective. It can also help you evaluate your investments in the customer experience to ultimately increase your revenue.
Ready to find out your own CVL? Follow along to determine how to calculate the Customer Lifetime Value associated with your business.
How to Calculate Customer Lifetime Value
The good news is that it’s actually quite easy to determine your customer’s worth using the CLV formula.
That said, there are a few data points you need to collect to create the foundation of the Customer Lifetime Value formula.
First, you must determine your Average Purchase Value (AVP). This refers to the average amount of money your customers bought during a given time period. To calculate this value, divide the total amount of money in purchases by the number of transactions during that time.
Calculating Average Purchase Frequency
Next, you’ll need to calculate your Average Purchase Frequency (APF), which measures the average number of customer transactions during a specific time frame. Simply divide the total number of purchases by the total number of customers.
Calculating Customer Value
Now it’s time to calculate your Customer Value (CV), which is simply your Average Purchase Value (AVP) multiplied by your Average Purchase Frequency (APF).
Calculating Churn Rates & Average Customer Lifespan
The last piece of the puzzle is calculating the Average Customer Lifespan (ACL), which refers to the average length of time a customer continues to buy from you. This is the number you get when you divide 1 by your Churn Rate (the percentage of customers you lost during that given amount of time). To get your Churn Rate, divide the number of lost customers by the number of customers you started with during that time period.
Calculating Customer Lifetime Value
Once you have these values, you’re all set to move on to the Customer Lifetime Value (CLV) formula, which is your Customer Value times your Average Customer Lifespan. The number you arrive at will be a monetary value, signaling how much you can expect the average customer to spend at your business over the length of your relationship.
A CLV Calculation Example
Now it’s time to see these calculations in action. Let’s say you run a bakery, and you’d like to determine the CLV of your entire customer base for the last six months.
In this case, you’ll start by calculating your Average Purchase Value.
Let’s assume, based on your calculations, your customers spent $10,000 within the last six months at your bakery, which is equivalent to 500 purchases.
As for your Average Purchase Frequency, you’ll divide the total number of those purchases (500) by the total number of your customers. After looking at your reports, you determined your bakery saw 125 consumers over the span of six months.
Now, you may recall that to get your Customer Value, just multiply the Average Purchase Value by the Average Purchase Frequency, so $20 x 4.
And last but certainly not least, you need to plug in your Average Customer Lifespan value, which is 1, divided by your Churn Rate. Since you had 125 customers and lost ten during those six months, when you divide those numbers and multiply by 100, your Churn Rate is .04 or 4%.
Now, you’re all set for the final step: multiplying your Customer Value by your Average Customer Lifespan to calculate your Customer Lifetime Value.
Based on this six-month window, you can assume your average customer will spend $2,000 at your bakery over the course of their connection with your brand.
Now that you’ve calculated your entire customer base, why not try segmenting your customer base or looking at individual customers to gather more insights? Understanding your CLV can help you make more educated decisions when it comes to your budget and where to put your marketing efforts.
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