February 3, 2014

Determining Your Company’s Customer Lifetime Value

customer salesAs small business owners, we intuitively know that loyal, returning customers are the best type of customers to have – especially in light of last week’s article where we talked about understanding the true cost associated with acquiring new customers.   But did you know it’s possible to actually put a value to them?
Why do you want to put a value to your customers’ loyalty versus just focusing on overall revenue?   To be clear, Customer Lifetime Value (CLV) is, at it’s most basic, a calculation showing how much money you expect customers to spend with you over the lifetime of their entire relationship with you.  There are a number of reasons why marketers use these figures but the two most important are:

1. It allows you to determine the absolute most you’re willing to spend to acquire new customers.   If you’ve determined that your CLV is $1000, then you can spend up to $999 to acquire new customers (if you choose to) and still have a positive return on your investment.

2. It enables you to determine whether your company has strong customer retention.  Loyal, returning customers aren’t customers you have to convince all over again to try your products.  They’ve already experienced it and are coming back for more.   So if you look at the numbers and you find that you aren’t getting customers returning again and again, what can you do or change so that you can keep those existing customers to keep them in the fold.

So how do you determine what your CLV is?  The most straight-forward is to determine how much, on average, customers spend with you in a month (or a year).  Then multiply that by the average number of months (or years) customers stay with you.

Let’s take a look at an example:

Through customer data that Bob has collected in his last two years of business, he’s able to determine that on average, his customers purchase from him once every two months for about 18 months before dropping off and spend an average of $24 each time they buy from him.

CLV = (18months/2) * $24 = $216

As such, Bob can now see that even if a customer is only spending $24 with him today, based on his CLV, that customer is actually worth $216.

As you can see, customer loyalty and retention can have a huge impact on your bottom line so we’ll talk more tomorrow about different ways to approach customer retention.  In the meantime, if you’re interested CLV, KISSMetrics has a wonderful Infographic that goes into more detail and provides more calculation options.

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