Is Customer Lifetime Value the secret of profitability?

B2B 6 min read

You have definitely heard about Customer Lifetime Value (usually abbreviated like "CLV" or "CLTV"). Most marketing-related podcasts use this term to create clickbait headlines, encouraging you to "increase your CLV in just a month".

But do you really know what Customer Lifetime Value is?

There is a brilliant work by V.Kumar, a world-recognized Professor of Marketing. The book is called "Customer Lifetime Value: The Path to Profitability" and is extremely up to date, even considering it was published more than 10 years ago!

In this article, you will be able to find a short excerpt of this book, seasoned with our interpretations.

Customer Lifetime Value definition

According to V.Kumar, CLV is "...the total financial contribution from the total period into the future - that is, revenues minus cost - of a customer over his/her future lifetime with the company and therefore reflects the future profitability of the customer."

Sounds pretty complex, isn't it? Let's simplify a little bit: CLV is a total amount of profit you will receive from a single client over the entire life of your relationship.

Basically, CLV is the exact metric that allows you to evaluate the importance of every single client, thus making much wiser strategic decisions.

Why is CLV important?

"For many years, firms did not focus on CLV due to lack of empirical evidence on the impact of CLV on their revenues and profitability. Several of these firms focused on increasing revenue by continuously acquiring customers." - V.Kumar

Again, these words were published in 2008! It's 2019 now and we still see a lot of businesses that are focused on customer acquisition, rather than building sustainable long-term relations.

Needless to say that this is not the approach you should use nowadays. This strategy already worked poorly in 2008!

Here are some reasons why should you calculate your CLV as soon as possible:

  • Harvard Business Review: "...acquiring a new customer is anywhere from five to 25 times more expensive than retaining an existing one. ";
  • The development of social media and digital marketing industry, which makes it cheaper to reach new clients. However, it still is too expensive to attract a customer who will only pay you once.
  • If you are only investing into promotion, without building client relations - you have a huge risk to multiple the number of unsatisfied clients.

Still don't get it?

Let's do some time travel: 25 years ago, when you would land a quick sale, without providing your client with proper service - all you would have is one client, who would rather pay your competitors.

But what about today? If you leave your client unsatisfied - one will not hesitate to share their experience on social networks. Moreover, one would definitely tag your company page and add a suitable hashtag!

What happens next? Let's say your ads' targeting worked well. Your messages reached the right prospect and there is a person who is interested in your service. What would they do next? Research you on social media! What would they find? That exact one negative review!

That is exactly why you have to change your mindset! Move from old-fashioned funnel to Marketing Lifecycle! Pay attention to CLV, not ROI!

How to calculate CLV?

Just like we have mentioned before, V.Kumar defines CLV to be "revenues minus cost - of a customer over his/her future lifetime with the company".

Depending on the age of your company, you can choose between two approaches of CLV calculation:

  • Historic. You choose a single customer you have worked with - and track the history of their purchases. Most probably, there will be several types of clients, so don't expect a lot of consistency here.
  • Predictive. Use it in case you are a young company, without any long-term relations in your track record. Then you have to consider your buyer personas' needs and pain-points . Using this data, you would be able to predict how much will they spend.

Please mind that there is no versatile CLV model, that would fit everyone. It depends on the industry you work within, the way you are getting paid, etc.

However, there is a versatile formula that should help you ;)

Customer Lifetime Value Formula

First of all, here's a Customer Service Metrics Calculator from HubSpot. It should be helpful.

Here's a CLV Formula from CrazyEgg:

Historic approach:

Let’s say a customer visits your website 10 times and spends $10 each time.

Your average gross margin is $5 after taking into account how much you spend to get the average customer to spend money, which means you’ll multiply $100 (the total amount spent) by $5 (your average gross margin) to get $500.

Predictive approach:

This average customer lifetime value formula requires several data points:

  • Average monthly transactions;
  • Average amount spent per transaction;
  • Average number of months your customers remain loyal;
  • Average gross margin;

Multiplying these numbers together will give you the predictive CLV.


Customer Acquisition Cost (CAC)

Using CLV approach, you would be able to plan your marketing budgets more efficiently. Partly, it has a lot to do with the Customer Acquisition Cost, allowing you to see which of your marketing expenses have the best ROI in a long-term perspective.

For example, Software Technology is the industry that has the highest CAC, according to DemandJump. However, most SAAS businesses pay a lot of attention to customer experience, while providing subscription-based services. These aspects allow them to have lasting Customer Lifetime. That is how they are profitable.

If they SAAS marketers were focused on ROI - they would make CAC lower, thus building less trustful relations with their prospects. Although, their CLV approach allows them to create profit while focusing on building long-term client relations.


How to improve your CLV?

To sum it up, we would like to encourage you to focus on building sustainable client relations, instead of spending all of your marketing budgets on new clients acquisition.

Use CLV approach on the stage of product development, market research, segmentation and client support. By doing so, you would be able to focus your resources on those clients that bring you most value.

Here is a couple of ideas how can you increase your CLV:

  • Reduce acquisition cost. Optimize your onboarding process so you don't waste a lot of time on that. That's one of the major expenses you should cut off on.
  • Improve your communication. Remember it is not only about your product/service. It is about experience. Make sure that your client enjoys working with you.
  • Focus on CLV, not ROI. It is a common case when marketers are focused on having an awesome ROI, thus ruining customer experience. Avoid these situations.
  • Understand the customer journey. If you know exactly who are your customers, what are their pain points - then you know exactly when do they need you. Having this information - you will be able to skyrocket your return rate.

Thanks for reading this far, be sure to visit our blog for more insights.

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