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Understanding Customer Lifetime Value – How to Project the Lifetime Value of Your Customers

Written by:   |  Analytics  |  May 1, 2017  |  0 comments

How much revenue does one customer add to your bottom line? What was the cost of acquiring that customer? Are you making money or losing it?

Understanding Customer Lifetime Value

Answering these questions for your business takes the accumulation of multiple pieces of data across multiple teams within your business, which requires know-how, participation, and a great deal of communication. In an ideal world, you would have access to your customer purchase database, which also ties into your marketing campaign spend. Unfortunately, this setup doesn’t exist for most marketers and we often need to coordinate both our Sales and Marketing teams to bring the data together. However, there is some light at the end of the tunnel for those running e-commerce on their website.I Instead of reaching out to your marketing and sales teams for their data, you can now pull it all out of GA (assuming everything is setup correctly).

What is Customer Lifetime Value?

Before we show you how this is done, let’s take a step back discuss the importance of Customer Lifetime Value. Customer Lifetime Value (CLV) is the projected revenue that a customer will generate during their lifetime with your company (from their first until their last purchase). Compare this to the amount of money you spent to acquire this new customer and you have a guideline that can help you determine the limit of what can be spent to recruit a new customer. If the cost of acquisition is higher than the lifetime value of that customer, then red flags should be waving.

Sounds Great! How Can I Measure This?

By now you may be asking how you can calculate this for your business. The following step-by-step breakdown explains:

  1. Step 1 – Determine Acquisition Cost. How much did you pay to acquire these customers?
    • Formula – Ad cost / New Users Acquired (make sure your time-frames are the same
  2. Step 2 – Average Order Value. How much do they spend per order?
    • Formula – Total Transaction Revenue / Total Number of Transactions in a given time period
  3. Step 3 – Orders Per Year? Quite simply, how many orders do they place per year (or week, or month, etc)?
    • Formula – This can be an assigned number based on your knowledge of your business.
  4. Step 4 – Retention. How many years (weeks, months) will they be customers for?
    • Formula – Also an assigned number based on knowledge of your business
  5. Step 5 – Net Profit. What is the net profit percentage of goods sold?
    • Formula – You may need to touch base with your Sales team to get this piece of information. Or you could make an educated guess based on industry trends.

Customer Lifetime Value in Action

Now, let’s put it all together! Here is an example of a good CLV vs a bad CLV.

Scenario 1: You run a paid search campaign for those looking to buy new boots in November. You spend $60,000 on the campaign, which gains you 1,000 new customers. On average, those customers spend $120, will come back 2 more times over the course of the year to buy additional items, and will stay a loyal customer for 5 years. Your profit margin on each pair of boots is 10%.

  • Lifetime Gross Revenue (Avg. Order Value * Orders per Year * Retention Period) $120.00 * 3 * 5 = $1,800
  • Lifetime Net Profit (aka Customer Lifetime Value) (Lifetime Gross Revenue * Net Profit – Acquisition Cost) ($1,800.00 * 10%) – ($60,000 / 1,000) = $180.00 – $60 = $120.00

You are making $120.00 profit from each new customer gained! If you did, in fact, gain 1,000 new customers from the campaign, that’s a lifetime value of $120,000 on just those customers. Nice work!

Now let’s look at the other side of the coin.

Scenario 2: You run a paid search campaign for those looking to buy new runners in July. You spend $20,000 on the campaign, which in the end gains you 100 new customers. On average, those customers spend $120, will come back 2 more times over the course of the year to buy additional items, and will stay a loyal customer for 5 years. Your profit margin on each pair of runners is 10%.

  • Lifetime Gross Revenue (Avg. Order Value * Orders per Year * Retention Period) $120.00 * 3 * 5 = $1,800
  • Lifetime Net Profit (aka Customer Lifetime Value) (Lifetime Gross Revenue * Net Profit – Acquisition Cost) ($1,800.00 * 10%) – ($20,000 / 100) = $180.00 – $200 = -$20.00

This is not good. By these calculations, we are losing $20.00 per customer gained. We need to fix this fast by looking at our channels, our copy, our creative, etc.

So Why is CLV So Important?

Understanding Customer Lifetime Value versus what it costs to acquire that customer will set your business up for success in the long run. Ideally, you are looking for a 3:1 ratio in terms of CLV to CAC. This shows that you are getting a great return on your money spent.

Based on these calculations, we can compare customer lifetime values amongst different channels (Paid vs Organic), different products (T-shirts vs Jeans), different time periods (Christmas vs Black Friday), and many more. We can determine who our most valuable clients are, how we acquired them, and how much it cost. Tell me that isn’t data any business leader would want to have when it comes to making business decisions!

 

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