Calculating customer lifetime value is an important part of marketing and advertising, particularly when it comes to those who work in the industry. But in order to calculate the CLV, you need to have some other information first. In this article, we will be discussing the entirely of the customer lifetime value, including the definition, the reason it exists, and the methods of calculating it that are out there.
The Term of Many Names
To avoid confusion, you should know that customer lifetime value (or CLV), is known by several other names, and they are all used pretty much interchangeably. First of all, the abbreviation CLTV also refers to customer lifetime value as does the term “lifetime value” and its abbreviation LTV along with the LCV abbreviation, which stands for lifetime customer value. In order to understand the term fully you have to be able to recognize it when you see it.
Why do you need a CLV Formula?
The reason that the customer lifetime value calculation is required is that it ties in with one of the modern trends in advertising and marketing that will likely become the new way to market products and services in the future. This method is known as customer-centric advertising. Customer-centric advertising is a method of marketing that targets the specific consumer – the individual – and make sure that their needs are being met. There are many other methods of marketing, but the customer-centric model is best for any medium. Unfortunately, it has only been with the advent of internet advertising that the customer-centric model has been able to come into being.
The Complexity of the CLV Formula
Calculating the customer lifetime value can be relatively simple or it can be complex, and the numbers of factors that affect that calculation are dizzying. The CLV formula can be as simple as a basic heuristic algorithm to an extremely complex predictive analysis formula.
Breaking down the CLV
Basically, the customer lifetime value can be defined as the dollar value of a customer relationship over the lifetime of the partnership between a specific advertiser and that customer. The formula isn’t perfect by any means, since it uses the current value of the customer as a base value, something that may decrease or increase over time, but it certainly is a much more effective method than most of the ways that people have tried to estimate customer value long-term in the past.
Why is the Customer Lifetime Value Important?
So, why is the customer lifetime value number so important anyway?
One of the reasons that the concept bears so much importance is the fact that
- it turns the focus of a company away from the products being sold in general, or any other bottom line concerns – particularly quarterly profits – to the actual customer and their needs.
- What many companies do not realize is that by shifting this focus, you are actually improving your bottom line, as long as you are able to look at it from the long-term perspective.
- In addition, it gives companies a number that they can then use to determine how hard they are going to work to get a number. In other words, it gives a company a hard number of what they are going to spend in order to get that customer to come and work with them – or stick with them in some cases. This payback is a major element in the marketing and advertising game.
The History of the CLV Calculation
Today, many companies are aware of the customer lifetime value proposition, and many even have experience and success in making those calculations. But where did the customer lifetime value formula start? Most experts agree that the CLV was first mentioned in a textbook on marketing that was published in 1988. “Database Marketing” may not be relevant today, but it was the first book to mention the term, and may even have coined the term back then. No one is really sure. But today, the term is used by many marketers all around the world.
How Has Customer Lifetime Value Changed Marketing?
There is no doubt that the customer lifetime value has changed marketing for the better. We have already mentioned the customer-centric shift that has happened due to the CLV calculations that have been taking place, and how much better the customer experience is for it. But by focusing on the customer experience rather than the quarterly report, companies are seeing much happier customers and eventually, that happiness pans out in the form of an increased bottom line.
The CLV has changed the way that companies look at customers as well. Now, instead of looking at a customer base as a whole – something that make some customers very unhappy – companies are trying to develop one-on-one relationships with the individual consumer. That means that they are able to increase customer satisfaction, tailor each experience to that individual customer, and inspire loyalty that really has no number that can be put on it.
Why Individualizing Customers is Vital
You may be wondering just why individualizing customers is so important. Let’s go over a few reasons why companies benefit from doing that.
Customer bases often have minority groups that are responsible for a significant portion of profits. The lifetime customer value formula allows you to identity and caters to that group.
The Actual CLV Formula
Let’s take a look at how to calculate a CLV formula by looking at the well-known coffee chain Starbucks. The first thing that you have to do is determine what the average purchase amount is. For some companies, it will be thousands of dollars. For Starbucks, the purchase amount is between $3 and $8. We’ll use $6 as our example amount.
The next thing you have to do is determine the purchase cycle. The purchase cycle is the number of times that a customer visits within the specified period. For a company that sells software, that purchase cycle might only be once a year or even less. For Starbucks, the purchase cycle is over a week. You calculate the number of purchases that happen in that purchase cycle next – in this case, three times per week.
So, in order to calculate the lifetime customer value – based upon the current figures – you simply have to multiply the amount by the times per weeks, and then multiply that by a customer’s lifetime.
In this case,
- the customer spends $18 a week,
- and if you use 30 years as an average (assuming that some people will stop buying after retirement)
- then 30x52x18=28,080.
So, for Starbucks, the lifetime customer value might be something like $28,080. Of course, that is assuming that the numbers hold up and that nothing changes their mind about how much they are spending, how often they visit or worst of all, which coffee chain they find most appealing.