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What is Customer Lifetime Value and How to calculate it?

What you will learn in this blog:
1. What is CLTV (customer lifetime value)?
2. Importance of knowing Customer Lifetime Value (CLTV).
3. Model to calculate CLTV.
4. How to improve LTV?

Understanding Customer Lifetime Value in marketing?

Customer Life Time Value is a critical metric every business should know! Customer Lifetime Value sometimes referred to as lifetime value (LTV) or customer lifetime value (CLV) is the total money a customer will spend during its business association with a company.

It indicates what a customer is worth for a company for the duration it remains a customer. In other words, it is the estimate of the total revenue generated by the company from a customer for the duration it will remain a customer with the company.

In simpler terms it means the profit margin a enterprise expects to earn over the entire life cycle of their relationship with the average customer.

Importance of knowing CLTV:

CLTV has a direct impact on the revenue of the company. If the CLTV is high, the company is generating more revenue per customer. A low CLTV indicates that the company needs to get more customers or increase revenue generated per customer for better results.

A company’s CLTV is also a strong indicator of its customers loyalty towards a brand. A happy customer will buy more from a company and will stay with them for a long time. Understanding Customer Life Time Value also helps the business decide on the amount it should spend on retaining its existing customers and servicing them better.

If the churn of customers is high and the average order value per customer is lower, it means that customer retention is less. The company will have to constantly add new customers to its basket to maintain its current revenue or increase it. It means it will have to spend more and constantly work towards acquiring more and more customers.

Identify ideal customers

It also helps identify ideal customers for a business. These customers buy more and stay with the company for years. Once identified, the company can focus on these customers and provide them with special offers.
It will contribute towards increasing customer satisfaction. Also, the customers would be delighted to continue their relationship with the company.

Plan Customer acquisition costs

Customer acquisition costs mean the amount a company spends on its marketing and sales to bring new customers into the pipeline. If a CLTV is ₹ 21,000 and a company spent approx. ₹15,000 to acquire each customer they earn ₹ 5,000 from each customer. If the customer acquisition costs for a company are very high, it will erode their profits from each customer.

How to calculate CLTV?

In mathematical terms: CLTV = Average Customer Lifespan * Customer Value

1. Average Customer Lifespan

It indicates the number of years a customer will buy products/services from a company. Here, we consider the number of years for which all the customers bought from the company. Then we average it out with the total number of customers to get the average customer life span. The formula to calculate it is:

Average customer Life span = Sum of customer lifespans / Number of customers

2. Average Purchase frequency rate

It is an average of the number of times customers buy a product/service from the company in one year. We calculate it by adding all the purchases made by all the customers in one year and then divide it by the total number of customers in that year.

Average Purchase frequency rate = Total number of purchases / Total number of customers

3. Average purchase value = Total Company revenue / Total number of orders

It is the average of the total purchases made by all the customers combined during a specific duration. In other words, for the average purchase value, we consider the total revenue generated by the company during a period, let’s say a year. Then we will divide it by the total number of orders during that same specific period.

Average purchase value = Total Company revenue / Total number of orders

4. Average Customer Value

From the previous calculations, we know how much a customer will spend and also how many times will he/she spend in a single year. We can multiply both these numbers together to know the average customer value.

Average Customer Value = Average Purchase value * Average Purchase frequency rate

We can also understand the total customer value by multiplying average customer value with the total number of customers in a year.
Example
To better understand this, let’s calculate it using some data from a company ABC Ltd. Mentioned below are some assumptions for ease of calculations. Let us consider there are a total of 4 customers – C1, C2, C3, C4.

In a year, C 1 buys 3 times from ABC and spent a total of ₹ 1500
C3 bought 6 times and spent a total of ₹ 7200
C4 bought 5 times and spent a total of ₹ 7000

Now the Average purchase value for each of the customers will be as follows:
• C1 = (1500/3) = 500
• C2 = (100/1) =100
• C3 = (7200/6) = 1200
• C4 = (7000/5) = 1400
The overall average purchase value for all 4 customers combined will be = (500+100+1200+1400) / 4 = (3200/4) = 800

Also, the Average Purchase frequency rate in a year = (3+1+6+8) / 4 = 18/4 = 4.5
And, the Average Customer Value will be, = 4.5*800 = 3600

Now let’s assume that C1 stays a customer of ABC for 5 years,
C2 is a customer for 1 year,
C3 is a customer for 8 years and
C4 is a customer for 10 years.

The average customer lifespan will be= (5+1+8+10) /4 = 24/4 = 6
Now, the Customer Life Time Value will be= 6*3600 = ₹ 21, 600
Multiple models can be used to calculate the Customer Life Time Value. However, we have taken a model that you can use for various types of businesses. As mentioned earlier, knowing a Customer Life Time Value is critical from a business viewpoint due to several reasons.
 

Focus areas to improve CLTV:

Businesses can improve the CLTV by focusing on the following points:

Deliver great customer experience

The customers keep coming back to you if you as a company can provide them with a great experience throughout the entire purchase cycle. It makes the customers feel valued.

Every time they buy more from you, they become more loyal to you. Always work on delivering a great customer experience, and they will keep coming back to you.

Special offers for special clients

Another great way of awarding existing loyal customers is to come up with some exclusive offers for them. It is your way of thanking them for being a critical part of your success. It also encourages them to buy more from you and hence makes the average order value bigger.

Customer relationship

Make sure your business works on developing a great relationship with the customers. Again, this is a part of the overall experience you provide to your customer that makes them keep coming back for more.

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