customer-lifetime-value

What Is Customer Lifetime Value? The Customer Lifetime Value In A Nutshell

One of the first mentions of customer lifetime value was in the 1988 book Database Marketing: Strategy and Implementation by Robert Shaw and Merlin Stone. Customer lifetime value (CLV) represents the value of a customer to a company over time. It represents a critical business metric, especially for SaaS or recurring revenue-based businesses.

Understanding customer lifetime value

Early adopters began using the concept soon after, and it has largely kept pace as the speed and complexity of the buyer journey increased at the turn of the millennium.

Customer lifetime value represents the total amount of money a customer is expected to spend on a business or product during their lifetime.

The CLV of a Ferrari owner may equate to $2 million, given the target demographic and quality or longevity of Ferrari’s sports cars.

The CLV of a coffee addict to Starbucks may be just as lucrative when one considers how many cups of coffee are consumed over decades. 

For businesses, this is a significant value because it determines how much money should be spent acquiring new customers versus retaining existing ones.

Ultimately, CLV is a measure of customer relationship profitability, which should be higher than the cost of acquiring the customer in the first place.

Calculating the customer lifetime value

Customer lifetime value can be calculated by multiplying the average order value, purchase frequency, and average customer lifetime measured in years. 

For example, consider a long-distance runner who, on average, purchases a $220 pair of shoes twice a year for five years.

The customer lifetime value is then 220 x 2 x 5 = $2,200. 

There are two general CLV calculation models.

Historical customer lifetime value 

As the name suggests, this model uses previous data to predict customer value and is helpful for businesses whose customers only interact with them over a certain period. 

Notably, the historical model does not consider whether the customer will continue to purchase from a business in the future. 

Predictive customer lifetime value 

Predictive customer lifetime value forecasts the buying behavior of existing and new customers.

It can identify the most valuable customers, products, or services and improve retention.

Why is customer lifetime value important?

Customer lifetime values provide clarity on customer acquisition and retention costs, but it also plays a vital role in the following:

Value-based customer segmentation

When an organization can identify its most valuable customers, it can send targeted VIP offers to reward loyalty.

Data describing these buyers’ demographics can then be used in lookalike modeling.

In this strategy, the business defines the attributes of a high-value customer and then looks for similar traits in other segments or demographics.

Lastly, value-based customer segmentation can be used to upsell low-value customers to increase their CLV.

Competitive advantage

moat
Economic or market moats represent long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.

Business has never been more competitive, particularly online. Customer lifetime value is a useful tool for market differentiation because it maintains a focus on the customer.

Growth

Some companies use customer lifetime value to justify spending more money acquiring new customers.

However, a better growth strategy is to reduce the churn rate by investing in customer retention.

Thus reducing churn and incentivizing repeat customer spend which are both critical factors for businesses based on recurring revenues.

What’s the difference between CTV and LTV?

The customer lifetime value is the dollar value attributed to a customer based on the purchase history or on a forecast of the total purchase the customers will make throughout the overall relationship with the brand.

LTV is the lifetime value of a customer, and it’s, in many cases, equivalent to the customer’s lifetime value.

This metric is highly used in SaaS, which is a business model primarily based on subscription revenues.

Since the subscription is usually spread across various months or years, a SaaS company tries to understand what money it can invest upfront in sales and marketing activities to acquire a customer.

Indeed, being correct about attributing the right customer lifetime value is critical to preventing a software company from facing hardship over time.

In many cases, SaaS companies fail to correctly attribute the customer lifetime value, thus overspending on customer acquisition.

In other cases, a SaaS company might do the opposite, accounting for a too-conservative lifetime value, which then slows down growth, as the company will be underinvested when it comes to bringing in new customers.

CTV and churn rates are critical metrics for any software startup.

Key takeaways

  • Customer lifetime value represents the value of a customer to a company over a predetermined time period.
  • Customer lifetime value can be calculated using historical or forecasted data by multiplying average order value, purchase frequency, and average customer lifetime measured in years.
  • Customer lifetime value allows an organization to focus its efforts on high-value customers where the return on investment is likely to be more significant. This strategy can be strengthened by increasing customer retention and reducing the churn rate.

Read Also: Net Promoter Score

net-promoter-score
The Net Promoter Score (NPS) is a measure of the ability of a product or service to attract word of mouth advertising. NPS is a crucial part of any marketing strategy, since attracting and then retaining customers means they are more likely to recommend a business to others.

Connected Decision-Making Frameworks

Cynefin Framework

cynefin-framework
The Cynefin Framework gives context to decision making and problem-solving by providing context and guiding an appropriate response. The five domains of the Cynefin Framework comprise obvious, complicated, complex, chaotic domains and disorder if a domain has not been determined at all.

SWOT Analysis

swot-analysis
A SWOT Analysis is a framework used for evaluating the business’s Strengths, Weaknesses, Opportunities, and Threats. It can aid in identifying the problematic areas of your business so that you can maximize your opportunities. It will also alert you to the challenges your organization might face in the future.

Personal SWOT Analysis

personal-swot-analysis
The SWOT analysis is commonly used as a strategic planning tool in business. However, it is also well suited for personal use in addressing a specific goal or problem. A personal SWOT analysis helps individuals identify their strengths, weaknesses, opportunities, and threats.

Pareto Analysis

pareto-principle-pareto-analysis
The Pareto Analysis is a statistical analysis used in business decision making that identifies a certain number of input factors that have the greatest impact on income. It is based on the similarly named Pareto Principle, which states that 80% of the effect of something can be attributed to just 20% of the drivers.

Failure Mode And Effects Analysis

failure-mode-and-effects-analysis
A failure mode and effects analysis (FMEA) is a structured approach to identifying design failures in a product or process. Developed in the 1950s, the failure mode and effects analysis is one the earliest methodologies of its kind. It enables organizations to anticipate a range of potential failures during the design stage.

Blindspot Analysis

blindspot-analysis
A Blindspot Analysis is a means of unearthing incorrect or outdated assumptions that can harm decision making in an organization. The term “blindspot analysis” was first coined by American economist Michael Porter. Porter argued that in business, outdated ideas or strategies had the potential to stifle modern ideas and prevent them from succeeding. Furthermore, decisions a business thought were made with care caused projects to fail because major factors had not been duly considered.

Comparable Company Analysis

comparable-company-analysis
A comparable company analysis is a process that enables the identification of similar organizations to be used as a comparison to understand the business and financial performance of the target company. To find comparables you can look at two key profiles: the business and financial profile. From the comparable company analysis it is possible to understand the competitive landscape of the target organization.

Cost-Benefit Analysis

cost-benefit-analysis
A cost-benefit analysis is a process a business can use to analyze decisions according to the costs associated with making that decision. For a cost analysis to be effective it’s important to articulate the project in the simplest terms possible, identify the costs, determine the benefits of project implementation, assess the alternatives.

Agile Business Analysis

agile-business-analysis
Agile Business Analysis (AgileBA) is certification in the form of guidance and training for business analysts seeking to work in agile environments. To support this shift, AgileBA also helps the business analyst relate Agile projects to a wider organizational mission or strategy. To ensure that analysts have the necessary skills and expertise, AgileBA certification was developed.

SOAR Analysis

soar-analysis
A SOAR analysis is a technique that helps businesses at a strategic planning level to: Focus on what they are doing right. Determine which skills could be enhanced. Understand the desires and motivations of their stakeholders.

STEEPLE Analysis

steeple-analysis
The STEEPLE analysis is a variation of the STEEP analysis. Where the step analysis comprises socio-cultural, technological, economic, environmental/ecological, and political factors as the base of the analysis. The STEEPLE analysis adds other two factors such as Legal and Ethical.

Pestel Analysis

pestel-analysis
The PESTEL analysis is a framework that can help marketers assess whether macro-economic factors are affecting an organization. This is a critical step that helps organizations identify potential threats and weaknesses that can be used in other frameworks such as SWOT or to gain a broader and better understanding of the overall marketing environment.

DESTEP Analysis

destep-analysis
A DESTEP analysis is a framework used by businesses to understand their external environment and the issues which may impact them. The DESTEP analysis is an extension of the popular PEST analysis created by Harvard Business School professor Francis J. Aguilar. The DESTEP analysis groups external factors into six categories: demographic, economic, socio-cultural, technological, ecological, and political.

Paired Comparison Analysis

paired-comparison-analysis
A paired comparison analysis is used to rate or rank options where evaluation criteria are subjective by nature. The analysis is particularly useful when there is a lack of clear priorities or objective data to base decisions on. A paired comparison analysis evaluates a range of options by comparing them against each other.

Related Strategy Concepts: Go-To-Market StrategyMarketing StrategyBusiness ModelsTech Business ModelsJobs-To-Be DoneDesign ThinkingLean Startup CanvasValue ChainValue Proposition CanvasBalanced ScorecardBusiness Model CanvasSWOT AnalysisGrowth HackingBundlingUnbundlingBootstrappingVenture CapitalPorter’s Five ForcesPorter’s Generic StrategiesPorter’s Five ForcesPESTEL AnalysisSWOTPorter’s Diamond ModelAnsoffTechnology Adoption CurveTOWSSOARBalanced

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