Customers are gained and lost over the lifetime of any company, but a truly great product or service can keep customers well fed, yet still hungry for more—figuratively speaking. This appetite for more is what continuously adds value to the company over the span of their relationship with customers. Follow our guide to calculating customer lifetime value or jump to our infographic below.
What is Customer Lifetime Value?
Customer lifetime value (CLV), sometimes referred to as lifetime value (LTV), is the profit margin a company expects to earn over the entirety of their business relationship with the average customer.
The customer lifetime value must account for customer acquisition costs (CAC), ongoing sales and marketing expenses, operating expenses, and, of course, the cost required to manufacture the product and services the company is selling.
Many Colombia Phone Numbers Listcompanies take a short-sighted approach by overlooking this valuable metric and instead optimize for a single sale in the near term. It’s still important to find new customers for the growth of the company, but optimizing the lifetime value of existing customers is also essential for a company to sustain a viable business model.
In fact, an increase in customer retention rates by only 5% has been found to increase profits anywhere from 25% to 95%.1 With this in mind, increasing the expected customer lifetime value is essential.
Customer Lifetime Value Calculation
how to calculate lifetime value and customer lifetime value with visual icons on purple background
Since customer lifetime value is a financial projection, it requires a business to make informed assumptions. For example, in order to calculate CLV, a business owner must estimate the value of the average sale, average number of transactions, and the duration of the business relationship with a given customer. Established businesses with historical customer data can more accurately calculate their customer lifetime value.
So, how do companies calculate customer lifetime value?
First, calculate the lifetime value by multiplying the average value of a sale, the average number of transactions, and the average customer retention period.
Lifetime Value = Average Value of Sale × Number of Transactions × Retention Time Period
Since the lifetime value of a customer is calculated in gross revenue terms, it does not take operating expenses into consideration. How much did it cost to make the product, advertise, and manage operations? Take these operating expenses into account when calculating customer lifetime value.
Customer Lifetime Value = Average Value of Sale × Number of Transactions × Retention Time Period × Profit Margin
Customer Lifetime Value = Lifetime Value × Profit Margin
If you’re looking for a simple way to calculate CLTV for yourself, try our Customer Lifetime Value Calculator.
Customer Lifetime Value Example
As an example, let’s create a hypothetical company to calculate the lifetime value of a customer.
The average sale for the boutique clothing retailer, Bellissi, is $50, and the average customer shops with them three times per year for two years. The lifetime value of this customer is calculated as follows:
Lifetime Value = $50 × 3 × 2
After calculating the cost of goods sold (COGS), overhead, marketing, and all other administrative expenses, Bellissi’s profit margin is 20%.
Customer Lifetime Value = $50 × 3 × 2 × 20%
= $300 × 20%
This calculation reveals the customer lifetime value of the average Bellissi customer is $60 — far less than the lifetime value calculated above. As a retailer, this number is used to project cash flow and to understand how many customers you must acquire and retain to reach desired profitability.
Customer Lifetime Value Contributing Factors
When considering what weighs on the customer lifetime value we must consider how the customer perceives the brand in question.
If a customer does not feel any brand loyalty or incur switching costs when transitioning their business to a competitor’s product, then it’s likely the customer lifetime value will be impacted negatively. We must also consider how scalable the sales and marketing efforts are when growing revenues and increasing customer lifetime value. Consider the following:
How often do customers stop shopping with a business they’ve previously patronized? The rate of attrition, or churn rate, differs from business to business, depending on the competitive advantage a business can command. Startups, for example, experience a much larger attrition rate than a given industry’s entrenched incumbents.