How To Calculate And Maximize Lifetime Value Of A Customer
For any company, an essential quantity to calculate is the lifetime value of a customer. This metric tells business owners how well their existing customers are resonating with their products or services. In return, your company will be able to identify areas to improve and establish solutions to expand your business further.
Calculating a customer lifetime value also helps with long-term plans. For instance, the value considers sales and marketing costs to show when the business can recoup sufficient investments to earn a new customer when we know what that customer is worth. Ideally, you want your customer lifetime value to be as high as possible. This means continuously revisiting and measuring the metric throughout the growth of your business.
If you want your business to gain and retain customers, you will need to learn what a customer lifetime value is, calculate it, and maximize it.
What is a customer lifetime value?
A customer lifetime value is the average amount of money a business can expect from a customer over the entire duration of their relationship. It accounts for a customer’s revenue value in comparison to their predicted lifespan with the company.
Your customers are not just worth the initial purchase that they spent on your company. They have a potentially much higher value if you’re able to retain them. In other words, the longer a customer buys from a business, the higher their lifetime value becomes.
This is when your marketing initiatives come into play. Be it your social media strategy or digital marketing campaign; they have a direct impact on your customer’s relationship with your brand. We go into further details about how you can increase the lifetime value of a customer later in this blog.
Importance of customer lifetime value
Customer lifetime value is crucial because it helps you identify the most valuable customers to the company. This allows you to invest in marketing campaigns directed at the target audience who will bring the highest revenue to your business.
Remember, you are investing money to attract new customers as well as to retain current ones through marketing efforts. However, acquiring a new customer is five times as expensive as retaining an existing customer.
Knowing your customer’s lifetime value allows you to improve your marketing strategies. Obviously, you still want to bring in new customers, but you also need to nurture brand loyalty amongst existing customers. A customer’s lifetime value teaches you not to forget about the old ones and pushes you to build substantial relationships that propel customers to buy from your business regularly.
How to calculate the lifetime value of a customer?
You don’t have to be a math genius to calculate this metric. All you need are five central values to determine your customer lifetime value. Here’s the breakdown:
1. Calculate average purchase value
You can get this number by dividing your company's total revenue by the number of purchases over a set timeframe — usually by the week, month, and year. The timescale is entirely up to you; just be sure to be consistent throughout your calculations.
For example, if your bubble tea store made 100 sales in one week and earned a total revenue of $500 in that same week, then your average purchase value would be $5.
$500 ÷ 100 = $5
Essentially, you are dividing the total revenue by the number of orders completed.
2. Calculate average purchase frequency rate
The next step is to observe how often a customer purchases from your business in a given time. You acquire this value by dividing the number of purchases made by the number of customers. The easiest way to work out how many different customers you have is by using a customer database. Perhaps that’s through a membership system, subscriptions, loyalty points, website logins, or crunching your accounting data. Obviously, web sales are the easiest platforms to obtain this data.
Continuing from the above example, customer A purchases from your bubble tea store three times a week. Customer B purchases four times a week. The average purchase frequency rate between these two customers would be 3.5 per week.
(3 + 4) ÷ 2 = 3.5
You will be calculating more customers — this is just a simple model.
3. Calculate customer value
Now that we know the average purchase value and purchase frequency rate, we can find their customer value. All you have to do is multiply both figures together.
As such, we will get $17.50 as the customer value for our bubble tea store over one week.
$5 x 3.5 = $17.50
Once you repeat this calculation on more customers, your average customer value will be more accurate.
4. Calculate average customer lifespan
You can attain this number by averaging the length of weeks, months, or years a customer continues to purchase from your brand. This means calculating the total sum of customer lifespans divided by the number of customers.
For example, Customer A frequented your bubble tea store for three years. Customer B frequents your store for six years. The average customer lifespan between Customer A and B would be 4.5 years.
(3 + 6) ÷ 2 = 4.5
5. Calculate the lifetime value of a customer
Finally, multiply your customer value by your average customer lifespan. This will give you the amount you can reasonably expect to profit from an average customer over the timeframe of their relationship with you.
Since we calculated our customer value every week, we need to multiply it by 52 to attain a yearly average. Based on our bubble tea case example, our value will be $4095.
52 x 17.50 x 4.5 = $4095
That’s a lot of bubble tea!
In sum, to calculate customer lifetime value, first, calculate the average purchase value, then multiply that number by the average purchase frequency rate to determine customer value. Once you calculate the average customer lifespan, you can multiply that by customer value to determine customer lifetime value.
Ways to maximize the lifetime value of a customer
Now that you know your customer lifetime value, how do you improve it? There are two main components to increasing your customer lifetime value — customer satisfaction and customer retention.
Customer Satisfaction
It is proven that making your customers happy will result in them developing loyalty to your brand. As studies show, 89% of consumers will purchase from a company again for its high-quality customer service. In addition, 58% of American consumers will switch companies because of poor customer service. Companies that are actively prioritizing their customer's satisfaction experience more revenue.
Customer Retention
As mentioned at the beginning of this blog, attracting new customers can be a pricey pursuit. Acquiring a new customer can cost five to twenty-five times more costly than retaining an existing one. It only makes sense that your business prioritizes keeping current customers.
Once you can develop a strong relationship with your customers, you'll gain more revenue. Thus, increasing your customer lifetime value.
One way to build customer satisfaction and retention is by levelling up your digital marketing game. Here are some examples:
Add them to your mailing list
You can use email marketing efforts to keep in touch with your customers even after they’ve purchased from your store. The emails you send can serve to update customers on new sales or special promotions.
A simple thank-you email goes a long way. Not only does it confirm your customer’s purchase, but it also shows that your company appreciates their patronage.
Engage via social media
Social media is a great platform to maintain a connection with your regular customers. You can follow, like, and comment on your customer’s posts. Additionally, you can post photos to build your online presence. For example, you repost photos that your customers shared regarding your products or services. This is a form of user-generated content which highly impacts purchasing decisions.
Provide special offers
Everyone loves to receive a discount when they are shopping. Even if you provide a 10% off coupon code, your customers will be more than happy to take advantage of it.
By offering your customers special offers, you encourage them to make more purchases while maintaining the mentality that they are saving money.
Concluding thoughts
Calculating the lifetime value of a customer matters more than you think. It directly correlates with your business revenue and customer retention rates. It also pinpoints valuable customers you should target and helps identify room for improvement in your marketing strategies.
If you’re not already analyzing your customer lifetime value, now’s the time to start!
FAQ
How often should I calculate my lifetime value of a customer?
You should not always rely on a historical value that you’ve calculated. As your business progresses, it is only natural that your customers evolve alongside you. They will not be the same as the customers you acquired one or five years ago. As such, to get the most accurate data, you should revisit and calculate your customer lifetime value regularly.
Does digital marketing help with maximizing my customer lifetime value?
Yes! Maximizing a customer’s lifetime value is essential for any business. To retain them, you need to invest in digital marketing campaigns such as SEO, social media marketing and email marketing to continuously keep your users engaged with your online store.
You can even rely on digital marketing tactics to maintain customer satisfaction, contributing to your customer lifetime value.
What are the factors that influence customer lifetime value?
Many variables affect a customer's lifetime value. Apart from your business service levels and initiatives to maximize the metric, other factors like the type of industry you’re in and the type of products or services you sell are all variables. Also, there may be factors that you cannot possibly predict without in-depth research, such as market stability.
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