What is customer lifetime value and how is it used in marketing?

If you needed a single statistic to underline the importance of retaining customers, let it be this one: according to one recent study, retaining customers increases the overall profitability of each one by an incredible 95%. When you also consider the fact that it costs approximately five times more to attract a new customer than it does to simply retain one that you already have, it’s easy to see why this is one goal that a lot of companies share.

Yes, new customers are a large part of your short-term strategy as a company. On a regular basis, your products, your services and your marketing campaigns should be bringing new people into the fold. But long-term gains are built by getting people to come back for more. Those repeat purchases don’t just make up a major portion of your overall revenue, but they are also part of how you’re able to remain competitive at the exact same time.

To that end, one of the most important metrics that you should be paying attention to is called Customer Lifetime Value, or CLV for short. As the term implies, this is the overall value that you can expect a customer to generate over the duration of their relationship with your business. If your products and services live up to their promises, and if your marketing campaigns remain effective, you should see that number begin to increase overtime.

Keeping a watchful eye on this metric doesn’t just confirm that you’re headed in the right direction. It can also help you optimize your ad spending and other marketing efforts, too. You can easily see which channels people are responding to and which ones they aren’t, thus allowing you to make sure that you’re getting as much value from every marketing dollar as possible.

But what is Customer Lifetime Value in a larger sense, and how do you calculate it so that you can use it in your own efforts? By keeping a number of important things in mind.

Customer Lifetime Value: A proven formula

Thankfully, calculating Customer Lifetime Value is a fairly straightforward process that requires just a simple metric: you take the average purchase value and multiply it by the average number of purchases that someone is likely to make.

So if your average customer spends about $100 at a time on your products or services, and you know that they are likely to make at least five different purchases over the course of their experience with your business, their Customer Lifetime Value would be $500.

The most important thing that this tells you about your larger marketing efforts in particular is how much value you’re getting out of your advertising spending. If your average customer generates $500 worth of sales but costs $550 to acquire, you’re ultimately losing $50. This would be a sign that you need to re-think your strategy and either find a way to market more effectively or optimize your existing resources so that you’re spending less money.

On the other hand, if every customer brings in about $500, and you’re only spending $100 to acquire them, you’re making about $400 on each one. That would be a clear indicator that your current efforts are working.

Overall, Customer Lifetime Value requires you to break things down into a number of smaller components.

1. Customer value

One element of the CLV formula involves being able to accurately calculate customer value on an annual basis. This is important, as the timeframe that you’re using to define “lifetime” must be stable to provide context and relevancy to the larger number you arrive at.

Based on the real data that your existing customers are generating, look at A) how much money people are spending on individual purchases, and B) how many purchases they are likely to make in a year. Multiplying those two numbers together will give you the average value of each existing customer over the span of 12 months.

2. Customer lifespan

Next, you need to be able to calculate customer lifespan in terms of years – something that you can also do with the right tools and your existing data. Take the average number of days between someone’s first order date and their last order date and divide it by 365 to convert the number into years.

3. Customer acquisition cost

Another crucial component of the CLV formula comes down to customer acquisition cost – in other words, how much money you’re spending to bring one new customer to your business. If you spent $5,000 on your last marketing campaign, and it generated 75 new customers who each made at least one purchase, each new customer would have cost approximately $66.66.

An example of Customer Lifetime Value calculation

For the sake of example, let’s say that you know the initial acquisition cost for each customer you have was approximately $100. You also know that while average customer revenue is about $400 in the first year, it increases by an average of $50 with each passing year. Most of your customers have at least a five-year relationship with your business.

Based on the customer revenue generated in year one alone, you’re making about $300 for every new customer you acquire. But with repeat sales over the next four years, that number increase to $500. Again, this underlines the importance of not only gaining new customers, but keeping them happy so that they want to make repeat purchases. This is also why you need to monitor your retention rate on a regular basis.

How to use Customer Lifetime Value in marketing

Once you know the Customer Lifetime Value for your business, it can be applied in a wide range of different ways to empower your larger efforts – particularly when it comes to your marketing.

1. Knowing your customers

CLV actually gives you a lot of insight into who your customers are, what they want, and what they need in ways that aren’t immediately obvious. If your customer acquisition costs are always going up (and thus your CLV is decreasing), it means something you’re doing isn’t working. Maybe your ad copy isn’t as effective as you think it is, or you’re spending money on the wrong channels. Either way, adjustments need to be made. It isn’t enough to just calculate CLV – you also need to be willing to act on it.

Likewise, if your acquisition costs are going down, but CLV is going up – either due to an increase average value per purchase or through more purchases being made in a year – that means you’re objectively on the right path.

2. Personalize your marketing

The types of insights that you derive from CLV calculations can also be used to generate more personalized marketing campaigns than ever before. Again, you’re talking about a metric that is based on objective fact – you know how much money people are spending, and you know how often they’re spending it. If they are satisfied, and if you’re reaching them with the right advertising message at the right time, those numbers should be going up.

This is key, as another recent study indicated that brands who rely heavily on personalized marketing tend to see a return on investment of 200% or more. Personalized marketing leads to better and more authentic customer interactions, which creates a more satisfying experience and usually leads to higher sales as well.

3. Measure your Return on Investment (ROI)

Speaking of return on investment, keeping a close eye on your CLV can also help tremendously to that end. Solid data collection, coupled with a careful analysis of factors like those outlined above, shed invaluable insight into the effectiveness of your marketing efforts.

If you’re spending $100 to acquire a new customer who only spends $50 on a single purchase and then never makes a repeat visit to your storefront, you’re losing money, and you won’t stay in business for very long. As your marketing efforts continue to gel with audiences, the amount of money you spend to acquire a new customer should be going down while the average amount they’re spending should be going up. If that isn’t true, something is wrong – end of story.

If your CLV is always ticking down, it means that your current advertising efforts are not as effective as you think they are. This doesn’t necessarily mean they’re of poor quality – it means that audiences are not responding to them in the way that they need to be. Changes need to be made, and positive changes will be reflected in a CLV that continues to increase once again.

This also underlines the importance of having a customer data platform at your side. It helps make sure that your CLV is being calculated using accurate, actionable data that you can then use to make the most informed decisions possible moving forward. Another study indicated that organizations who utilize a customer data platform often grow at a rate of 9 times higher per year than those who do not. They also see a year-over-year revenue growth that is 3 times higher, too.

4. Increase CLV over time

In the end, it’s important to understand that CLV can give you a “bird’s eye view” of not just your advertising, but the effectiveness of your entire business as well. For example, think of all the potential sources for new customers and repeat purchases that you aren’t actually paying for.

You acquire one new customer, and they’re so satisfied that they tell a friend, who in turn makes a purchase. That new customer came from word-of-mouth, which cost you nothing.

Or, one new customer is so satisfied that they immediately make three more purchases. Your advertising generated the first sale – the quality of your products and services were responsible for the rest. Both of these examples would still get factored into your larger CLV equation.

Nevertheless, your Customer Lifetime Value should always be increasing over time. If it is, it doesn’t just tell you that you need to double down on your marketing efforts because they’re already quite effective. It sheds invaluable light into the overall health and trajectory of your business as a whole, which in and of itself is the most important benefit of all.