One of the first mentions of customer lifetime value was in the 1988 book Database Marketing: Strategy and Implementation written by Robert Shaw and Merlin Stone. Customer lifetime value (CLV) represents the value of a customer to a company over a period of 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 an important value to know because it determines how much money should be spent acquiring new customers versus retaining existing customers. 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
For example, consider a long-distance runner who on average purchases a $220 pair of shoes twice a year for 5 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
Predictive customer lifetime value
Predictive customer lifetime value forecasts the buying behavior of existing and new customers. It can be used to identify the most valuable customers, products, or services, and improves retention.
Why is customer lifetime value important?
Customer lifetime values provide clarity on customer acquisition and retention costs, but it also plays an important role in:
- Value-based customer segmentation – when an organization can identify its most valuable customers, it can send targeted VIP offers to reward loyalty. Data describing the demographic these buyers occupy 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 – 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 as justification for 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 by incentivizing repeat customers spend which are both critical factors for businesses based on recurring revenues.
- 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.
Connected Business Frameworks
Main Free Guides: