How to calculate and use the Customer Lifetime value?

What is Customer Lifetime Value?

Customer Lifetime Value is the estimated profit generated by a consumer throughout the duration of their business relationship.

Unlike NPS (Net Promoter Score) or CSAT (Customer Satisfaction Score), which provide satisfaction data, CLV is a tangible measure to estimate future revenue.

The CLV (also known as LTV/CLTV) gives the sum of the net earnings generated by your customers throughout their business activity with your company. This sum allows you to know the expenses of your sales, marketing and customer departments. 

The CLV also allows you to manage strategic actions, especially commercial ones, and toestimate your next marketing budgets. 

How to calculate the customer lifetime value?

The CLV includes several terms that must be calculated beforehand. It includes the life of a customer, the frequency of purchase and the average basket.

Let's first look at these indicators.

1. Calculation of the life of a customer

The lifetime of a customer is the number of years or months of business relationship between your customer and your company. To answer this question, ask yourself, when was the last time your customer placed an order with you?

This represents the time during which a consumer remains loyal to your company. In other words, it is calculated by taking the inverse of the customer attrition rate .

Lifetime = 1/customer attrition rate

Lifetime = 1/ (1-retention rate). 

2. Retention rate calculation

The retention rate is simple to calculate. It is the proportion of customers who place orders from one period to the next. It is the opposite of churn. 

3. Calculation of the purchase frequency

Purchase frequency is the number of times your customer has purchased your services or products during your business relationship. To track this indicator, ask yourself how many times your customer has ordered from you?

Purchase frequency = number of orders / unique customer 

4. Calculation of the average value of orders

Finally, the average basket represents the average value of orders placed by the customer during your business relationship. It is calculated by dividing the number of orders placed by the customer by the total sales made with this same customer.

Average basket = (Sales made by the customer) / (number of orders placed by the customer).

Calculation of the turnover generated by a customer 

It is calculated using the following formula: 

Sales = customer revenue - (acquisition costs + customer service costs)

By aggregating these indicators, you can calculate your customer lifetime value. CLV is also associated with the average basket, purchase frequency and customer lifetime products.

CLV = (average basket) x (purchase frequency in months) x (customer lifetime).

This allows you to track the profits made by each customer within your company.

Example for a SaaS company

Let's take a few examples to understand the calculation of the CLV. 

Consider the SaaS company Tout Pour La Logistique (TPLL). TPLL offers average subscriptions of €300 per month. Customers subscribe on average for a period of 7 years.

The purchase frequency is monthly and the subscription is automatically renewed.

The average lifespan of a customer is 7 years.

The average basket is 300 € which is the monthly subscription rate.

Thus the CLV (TPLL) = 300 x 12 x 7 = 25 200 €.

Example for a B2B company

Now consider Business 4 Friends (B4F). B4F sells financial products and services to associations.

The frequency of purchase is one order every two months.

The lifetime of a client is approximately 5 years.

The average customer basket is €2,000.

CLV (B4F) = 2 000 x 6 x 5 = 60 000 €.

B4F therefore has a CLV of €60,000. 

Example for a company selling security equipment

Let's imagine that SecureLife offers a range of security services for companies, including an intrusion security package. The reference period is a calendar year.

The total turnover for this period is €1,250,000. SecureLife has issued 2,800 invoices for these clients and has 140 customers. It has a retention rate of 80%. 

SecureLife's purchase frequency is 20 orders per year.

The lifetime of a client is approximately 5 years.

The average basket of a customer is 8 929 €. 

Thus SecureLife has a CLV of €892,857.

How to interpret the customer lifetime value?

The CLV is an estimate of future profits. It allows you to forecast your future marketing and business strategy budgets.

Indeed, once you know how to calculate the CLV, it is important to know how to use it to define your marketing budget and your CAC (Customer Acquisition Cost).

Let's look at CAC's strategy. 

The CLV calculation helps you set the upper and still acceptable limits of your acquisition cost. This allows you to build realistic, profitable and sustainable customer acquisition strategies without jeopardizing your business.

In particular, you must be careful not to have a CAC that is greater than or equal to your CLV. If your average CLV is similar to the cost of acquiring a new customer (advertising, marketing, offers, etc.), this can cause cash flow and profitability problems for your company. You may be losing money. 

If you find yourself in this situation, it means that you need to make strategic adjustments as soon as possible in order to reduce your acquisition costs or increase your Customer Lifetime value. 

How to improve customer lifetime value?

In order to improve your CLV, it is essential that your different teams collaborate and share their data with each other. The more comprehensive the information flows, the more likely you are to acquire and retain your consumer. 

Internally, you have to ensure a good organization between your departments, whether they are marketing, communication, customer or after sales service.

To do this, identify the touch points that create value for your customer, target the metrics to track when creating the customer journey map, and measure the revenue obtained at each touch point.

In order to increase your CLV, you can therefore decrease your customer acquisition cost or increase your customer's average basket, lifetime and purchase frequency.

This includes implementing upsell strategies for your product or service sales, and improving customer service in order to retain your customers.

You can also do this by offering discounts or various advantages in order to encourage a regular purchase frequency.

Why track customer lifetime value?

As you can see, improving your CLV allows you to increase your overall sales and to decrease your CAC. It is one of the essential metrics to follow for your company.

This gives you a better vision of what your customers bring to you (in market value) compared to what you have spent on them (marketing, product development, customer service...).

Tracking your CLV allows you to implement strategies to make your customers more profitable and increase your profits.

Break-even points

Measuring your customer lifetime value also allows you to set alert thresholds on the profitability of your company. Indeed, to be profitable, your CAC must imperatively be lower than your CLV. 

Set a target CAC/CLV ratio that will depend on the phase of your business in order to have a global vision of the health of your business. 

If we take our example of TPLL. Taking into account the stage of development of the company and its business typology, it would be advisable to have a maximum ratio of 1/3. This means that its CAC should be less than 3 times its CLV. 

With a CLV of 25,200, its CAC should be : 

CAC = CLV X 1 / 3 = 8 400 €.

Its CAC should not exceed 8,400 €. 

In addition, you can also track the cost of customer retention. This is the cost of retention and customer experience per consumer. It is calculated as follows: 

CRC = (cost of loyalty campaigns + cost of customer experience) / unique customers

This allows you to fine-tune your CLV calculation so that it best reflects your actual revenue generated per customer over their lifecycle, excluding their costs.

Segmentation of your personas

If you want to go further in tracking this metric, you can segment your customers into persona types in order to get an idea of the profit generated per persona type. 

Indeed, every customer is different. Given this reality, it is possible that some customers are financially unprofitable, but very loyal over the long term.

Conversely, other customers may be very profitable over a short period of time, but change suppliers regularly. 

Finally, you can perform this segmentation according to their demographic origins, their demographic profiles or their sectors of activity . Make these same calculations to have a more precise vision of the organization of your sales and your expenses.

As you can see, it is important to follow the CLV in order to have a vision of the profitability and viability of your business model and the health of your company.

You can improve your CLV by driving purchase without changing your marketing budget, by automating certain actions, by defining your segmentation and by increasing customer satisfaction. The main thing is to monitor your CLV and to set precise objectives and thresholds!