Customer lifetime value (CLTV) is the value a customer contributes to a business over the entire lifetime at that company. To put it in other words, CLTV means the amount of money a shopper is going to spend on your products or services for as long as they are your customers. It’s not about the money they already spend, it’s a prediction of how much they will spend overall.
Of course, customer lifetime value is impacted by multiple factors, from customer service up to the products themselves. Calculating this value it’s crucial, especially during the customer acquisition process because it will show you if your customer acquisition cost is too low or too high. Usually, the ratio between the customer acquisition cost and customer lifetime value is 1:3.
How to calculate customer lifetime value?
There are different approaches to calculating the lifetime value of a customer and it depends on the type of business and its customers. However, the most common formula for calculating the customer lifetime value is:
Lifetime revenue= Average value of sales x Number of transactions x Retention time
Customer lifetime value (customer net profit) = Lifetime value x profit margin
Let’s take a coffee shop as an example. An average customer goes to the shop 3 times per week and they purchase 1 coffee that costs $5. Most customers tend to remain loyal to the coffee shop for 2 years. This means that the lifetime value is $1560. If the profit margin is 30% for the coffee shop, then the customer lifetime value is $468.
Why is customer lifetime value important?
It’s essential to calculate and monitor the lifetime value of your customer because it impacts all of your choices when it comes to marketing, sales, and development. When you know the average lifetime value of a customer, you will also know how much money you can spend on customer acquisition. Also, it will show you why customer loyalty is important for any business. Loyal customers end up spending more and recommending your products to others.