Knowing what to expect from a situation is a fantastic feeling, both in business and in life.
Yes, the unknown can be fun, but I bet you love the peace of mind in knowing just how much money will land in your bank account each month, the distance a full tank of gas will take you, and about how long your smartphone battery will last.
These details give you safety and security—a foundation you can then plan, experiment, and enjoy your life from.
The same sentiment applies to your company’s customer lifetime value.
CLV is a core metric that shows you what to expect from an average customer when it comes to revenue, and it can be a ferocious driver of your customer retention and loyalty efforts. This guide has everything you need to nail your CLV—without the fluff you don’t need.
How to Calculate Customer Lifetime Value—No Fuss, No Muss
In simple terms, it’s the metric that defines what amount of money, on average, an individual customer spends on your products or services. Don’t be fooled by how basic it sounds—tracking CLV can supercharge every team and decision in your company.
It helps you:
- Minimize spend to maximize profits: Acquiring new customers costs you money. By understanding the revenue a customer brings you over their relationship with you, you can optimize your spending to make customer relationships profitable.
- Set sustainable sales goals: For example, instead of aiming to win as many new customers as possible regardless of their quality, you can focus on closing fewer sales—but with the potential for higher CLV.
- Improve marketing and sales: Customer lifetime value often varies by the segment, acquisition channel, or campaign. Use this metric to build more successful marketing strategies and sales efforts.
- Double down on customer retention and loyalty: Unless your business model is making a single sale, your CLV depends on how often your customers buy from you and how much they spend on each occasion. Enter customer loyalty and retention.
With customer lifetime value in your sales KPI toolkit, you can make the best decisions for your business across your marketing, sales, product development, and customer support to find (and retain) high-value customers.
A Simple Customer Lifetime Value Formula You Can Use
There isn’t just one, universal way of calculating customer lifetime value. If we’re honest, CLV formulas can get complex and overwhelming, but we know you’re here for a simple approach.
Calculating CLV is focused on three parameters: average order value, number of purchases per month or year, and the length of the customer relationship (in months or years).
The customer lifetime value formula is as follows:
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Customer Lifetime Value (CLV) = average order value x number of purchases per year x length of customer relationship in years
In other words, when this salon’s clients are satisfied enough to return time and time again, they’re worth over a thousand dollars to them for the duration of their patronage.
Let’s look at another example, this time for infrequent but larger purchases.
Look at the example this way: if customers buy one iPhone, but end up not being happy with the customer experience or support they got and therefore never return, this store loses upwards of $2,500 for each such customer.
For Seth Besse, the CEO of a parent support platform Undivided, the role of CLV is to gain a deeper understanding of the enduring impact and relationships they build with those they serve. He says, “We first consider the average revenue generated per customer over their relationship with our platform. This includes the subscription fee and any additional services they used. We then assess the average duration a customer stays engaged with our platform.”
Undivided’s CLV calculation also factors in the acquisition and servicing costs for that customer—something you can choose to include immediately or consider in later analysis.
Dig Deeper: How to Get Granular With CLV
Let’s unpack the customer lifetime value further, starting with the building blocks of the CLV formula:
- Average order value: The average revenue you make from one customer, divided by the number of purchases they made.
- Number of purchases per year: The average purchase frequency in a year.
- Length of customer relationship in years: The length of the entire customer journey, expressed as the number of years.
You’ll find this information in your CRM, your point-of-sale (POS) back end, your invoicing system, or some combination of these—all depending on your type of business.
Your business type will also dictate how you calculate the customer lifetime value formula. Take these examples:
- SaaS companies can lean on their pricing plans, billing frequencies, and their average customer lifecycle.
- Online service providers like agencies will use retainers and typical contract lengths.
- Some eCommerce companies will leverage data from customer accounts to understand average order value, purchase frequency, and time period during which customers make repeat purchases.
- Brick-and-mortar or local service providers can use details from their booking system to learn how frequently clients need their services.
The scenario in which you may struggle to support your customer lifetime value with real data is if you only do business in-person and without a way to track repeat purchases. If that’s you, this is your sign to find that way—it will pay off.
Before we get to other metrics and KPIs that make up the big picture together with CLV, it’s important we mention two key ways of calculating customer lifetime value: historical and predictive.
Historical CLV uses past data to help you understand behaviors and purchase patterns from your current customers. You can add context to it with customer feedback and understand how different customer segments influenced your bottom line and profitability.
Predictive CLV uses details about your existing customers to predict future revenue from an average customer. It’s a forecasting method to gauge how your marketing efforts, sales techniques, and product strategies will impact your results based on what you’ve learned so far.
In both cases, you’re essentially using the same customer data; you’re learning about your customer base, their purchase behavior, and spending. What’s different is how you put that data into practice—one is to understand what has happened so far, and the other is to set expectations for the future, as it relates to the lifetime value of a customer.
How Customer Lifetime Value Relates to Other KPIs
Customer lifetime value is a fantastic insight. But on its own, it doesn’t tell you enough.
Put it this way: let’s say your customer lifetime value calculation taught you your business makes $1,000 from each customer over their relationship with you. On paper, that looks excellent—your sales brain is happy.
But then you speak to folks in charge of the marketing budget, and you learn it costs you nearly as much, and sometimes more, to win that customer. That’s the cost of Facebook ads, social media tools, billboards, and marketing staff salaries divided by the number of customers marketing brings in.
Something’s off, right? That’s because CLV is only one piece of the puzzle. There are a couple more important metrics you need to track and analyze to complete the picture and make the best possible moves forward.
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CLV and CAC
The total value of a customer relationship only works when you pair it with its counterpart: customer acquisition cost, or CAC for short.
You can calculate CAC in different ways. For example, if you want to know your CAC for a specific campaign, you can consider the cost of media production and paid ads. But when looking at customer acquisition cost overall, you might want to include the cost of salaries, software, and other ongoing expenses that contribute to your CAC.
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The best way to consider CAC in context with CLV is by looking at the ratio between the two. A CLV/CAC ratio higher than one indicates profitability for your business over the long run—it means you’re spending less to acquire them than the revenue they’ll bring.
Ideally, you’ll see a CLV/CAC ratio closer to three. This implies your customer relationships bring in three times more revenue compared to the cost of winning them. It’s a sign of healthy profit margins—a healthy business.
Best thing you can do? Calculate your CLV/CAC ratio and monitor if and when it changes. Any dips are worth investigating to prevent future issues, like an unexpected drop in profitability.
CLV and NPS
Net Promoter Score, or NPS, measures customer satisfaction and brand loyalty. It does so by asking customers this question: “On a scale of 0 to 10, how likely are you to recommend our business/product/service to a friend or colleague?”
While CLV measures the financial aspect of customer relationships, NPS gives them context and depth. Higher NPS scores can often correlate with high CLV—depending, of course, on what you deem a high customer lifetime value.
Best thing you can do? Track NPS and compare it to your CLV. If you can, look at it through the lens of different customer segments to spot any patterns. Then, look for opportunities to delight customers and turn them into your brand ambassadors—happy customers love a referral or loyalty program, which gives you a chance to make your customer acquisition cost even lower!
CLV and Churn
Churn rate is the percentage of customers who stop using your product or service during a defined period. It’s a common customer retention metric with startups and SaaS companies—and easier for them to track due to a subscription business model—but it applies to every business under the sun in one way or another.
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Churn rate is the exact opposite of customer retention rate, the percentage of customers who buy from you again.
Churn directly impacts your CLV—when customers stop buying, they’re no longer a source of revenue for your business. Some churn is to be expected, but if it goes beyond the usual for any reason, your CLV will eventually drop.
Best thing you can do? Focus on customer retention strategies, including loyalty programs, exceptional customer service, and quality onboarding. When churn happens, do your best to understand what led to it and how you can prevent it in the future. Your CLV will thank you for it.
Staying on Top of Your Customer Lifetime Value: Benefits and Challenges
Calculating your CLV, and doing it right, is a superpower. You’re about to learn why—but not without a few challenges and potential pitfalls to keep an eye out for.
CLV Benefit #1: Gives You Peace of Mind
Without profit or some kind of external funding, you don’t have a business. You have an expensive hobby. The funds coming into your business are what ensures you can pay your vendors, employees, consultants, materials, utilities, and whatever else you need to pay to keep serving your customers.
When you understand the revenue an average customer lifespan brings you, you can rest assured you can pay those people and those bills. The cash flow, and knowing where your gross margin sits, means you can plan products, launches, campaigns, and other activities that support your business—so that, in turn, your business can support you and your team.
That’s priceless.
CLV Benefit #2: Helps You Find and Convert Dream Customers
How much money does an average customer spend with us over their relationship with our business?
That’s the core question customer lifetime value answers. But it also reveals who your most valuable customers are, and gives you the chance to dissect that segment further.
You can dig deeper into a group of your best customers and look for answers to questions like:
- How did these customers find out about our brand and what we offer?
- How long did it take for them to convert?
- Which channels did they use to interact with our company and/or our sales team?
- Which product or service did they originally purchase?
- Have they upgraded or otherwise changed their purchases over time?
- How often do they reach out for support?
You can then reverse-engineer these details to find more of those dream customers and drive your CLV even higher.
CLV Benefit #3: You Get to Make Smart Budget Decisions
When things get tough, we instinctively throw money at the problem. Maybe you decide to invest aggressively in LinkedIn and YouTube ads, and you get an instant spike in leads. Problem solved, right?
Wrong.
It’s not until months later you’ll learn that these leads are low-quality—meaning poor conversions, and less spend than your average customer.
By understanding the long game—the full picture that CLV paints—you’re no longer afraid to pause for a beat when things aren’t going well. Instead of rushing into a big new lead generation campaign, you spend time giving your current customers what they’re potentially missing and learning about reasons for recent churn.
Christy Pyrz, the CMO of Paradigm Peptides, believes CLV helps businesses prioritize the right activities in their business. She says, “Most small business owners will tell you that one of the most challenging issues they have is not having the staffing or other resources to maintain their customer relationships.
“But with the right data, you can find areas to streamline and automate to fill those gaps. The customer journey to conversion can be long and tricky, but there are always opportunities to find areas in which you can use technology or limit steps to reduce the strain. CLV shows you those areas,” she adds.
CLV Benefit #4: Drive Your Pricing Strategy for Long-Term Success
A $1,000 product purchased once every five years leads to an identical CLV as a $200 product bought every year, or a monthly purchase of a $16 item.
That’s to say, there’s no ultimate business model, pricing approach, or product assortment that will give you the CLV you want. It’s easy to think you can slightly increase your prices to drive CLV up—but that price increase might drive customers to a more affordable competitor, which is the exact opposite of the result you wanted.
By regularly tracking and reflecting on your CLV, you can understand the changes in your pricing and product offering that led to different results—and act accordingly.
CLV Benefit #5: Develop the Ultimate Customer Retention Programs
Repeat purchases are the lifeblood of a healthy business.
For most types of businesses, they’re what makes customer lifetime value a relevant metric. Data from Smile.io on the eCommerce industry revealed a first-time customer has a 27 percent chance of returning to your store. That number grows to 49 and 62 percent after making a second and third purchase, respectively.
In other words: the more they come back, the bigger the chance they’ll come back again.
Use CLV insights to double down on customer retention programs and strategies like a loyalty program that offers perks and discounts (that’s what MyProtein does) and programs for community and ambassadors (like Asana offers). Other customer retention strategies that belong on the list of your options include omnichannel customer support and creating personalized experiences.
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3 Key Customer Lifetime Value Challenges You Shouldn’t Ignore
There are some challenges you may run into when it comes to customer lifetime value—use these tips to avoid them:
- Make sure you’re using accurate, complete data: One Econsultancy report found that driving CLV is a high or medium priority for over 70 percent of companies, but for over half of them, CLV isn’t even a measured and reported KPI within the business. Make sure you have accurate, updated data and centralize it for all future uses, so your CLV metric is comparable over time.
- Don’t ignore customer feedback: Your CLV doesn’t exist in a vacuum. Hitting a certain number isn’t enough—always keep a pulse on your digital customer experience to prevent future issues, like a sudden spike in churn or a flood of negative reviews.
- Make CLV a company-wide priority and initiative: Marketing folks need to internalize how their efforts support sales—the same goes for sales and customer support. Each customer touchpoint influences their future spend, CLV impacts the financial health of the company—and that influences everyone in the business.
5 Time-Tested Ways to Increase Customer Lifetime Value
We’d never let you go without tips to increase your CLV! Here are our favorites:
1. Be Best-in-Class for Customer Service
Great customer service can seem like a strange flex—you don’t want your customers to have an issue with your product just to show off your customer support skills. No business does.
But sooner or later, some of them will have an issue, and that’s your chance to delight them. The shoe company Zappos made a name for themselves thanks to their exceptional customer service decades ago.
And as for the B2B world, here at Close we’ve built a world-class support team that go above and beyond to help customers solve their problems (with a 15-minute response time!).
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Build up and streamline a customer support operation so strong that customers will be happy they’re your customers even after a problem.
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2. Work on Upselling and Cross Selling Customers
Upselling is the practice of encouraging customers to go for a higher-priced option to the one they’ve originally chosen. Cross-selling is selling additional products on top of what they’ve decided to buy.
These are slightly different activities, but their aim is the same: increase that customer’s purchase value. Upselling or cross-selling just for the sake of it won’t land well—deeply understanding your target audience and offering them the best options for their needs is what will. Embrace it and watch your CLV rise.
3. Crush Your Customer Onboarding Strategy
Onboarding is usually synonymous with SaaS companies that want to lead their new customers to their first a-ha moment in the software, which increases their chances of loving it and sticking around.
But you can use onboarding for many types of products and services. For example:
- An electronics store can set up the customer’s new laptop or smartphone and provide user-friendly manuals and quick tips.
- A hair stylist can demonstrate styling and care tips after a haircut, and send the client home with a checklist-type resource.
- A real estate agency can onboard a new client looking to buy a home by explaining the process of offers, negotiation, insurance, financing, and closing.
You get the gist. Onboarding is a mighty customer delight tool—use it.
4. Reward Loyal Customers
Loyalty programs can be anything from points system and cashback offers to exclusive perks and tiered rewards and discounts. Before you choose one, survey your best customers or research your target market to learn the types of loyalty programs they prefer and enjoy most.
It should feel easy to use and a delightful addition to your already great customer experience—that’s the key to seeing the CLV results you want from it. Get inspired by well-known loyalty programs like the one from Sephora, Alo Yoga, and Starbucks.
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5. Use Your CRM to Improve the Quality of Customer Relationships
The best people to have around are the ones who remember your birthday, ask about your kid’s sports, or bring up that work project you mentioned the last time you spoke.
The same applies to your customer relationships. When you remember what they bought, what they needed the last time they spoke with customer support, or a specific thing they struggled with—they notice, and love it!
The best part? You don’t need to remember anything. Your CRM will do it for you. Past purchases, sales call logs, notes from customer support calls, communication preferences, and even birthdays all live a couple of clicks away at any moment, ready for you to personalize each customer interaction.
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If you want a CRM that’s intuitive, fast, and powerful all at once, you’ll love Close—even if you’ve never used a CRM before. Grab your 14-day free trial of Close today.
