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.Â
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.Â
There are two general CLV calculation models.
Historical customer lifetime valueÂ
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.Â
Notably, the historical model does not consider whether the customer will continue to purchase from a business in the future.Â
Predictive customer lifetime valueÂ
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
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.
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.
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 marketingstrategy, since attracting and then retaining customers means they are more likely to recommend a business to others.
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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.
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Focus on what they are doing right.
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Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
