THE CUSTOMER LIFETIME VALUE CALCULATION: WHY IT’S USEFUL AND HOW TO DO IT RIGHT

You know the phrase “work smarter, not harder”? If you like to live by that maxim, you probably love the concept of customer lifetime value. Customer lifetime value (CLTV) is the prediction of the net profit you’ll receive from the entirety of your business’ relationship with a given customer, and it’s an incredibly useful tool when determining what’s worth your time and money, and what isn’t.

Covered in this post:

  • The different ways to calculate CLTV
  • Whether you need multiple CLTV calculations
  • Applying your CLTV knowledge
  • How to increase CLTV

The different ways to calculate CLTV

As LimeLight’s Director of Analytics, Chad, would say, “you can go up to five different business owners, ask them how they calculate CLTV, and they’ll give you five different answers. Oh, and they’ll all think that they’ve figured out the one true way to do it.”

Boiled down, here are the main ways to calculate CLTV:

Keeping it simple

Historical Customer Lifetime Value Calculation

This method doesn’t take into account the future potential of each customer, only how much they’ve been worth to your business up until present day.

Calculating historical CLTV

Predictive Customer Lifetime Value Calculation

This method is the most straightforward way to take into account the value of the customer in both the past and the future.

calculate predictive customer lifetime value

Some versions of this calculation are bounded by time, so you might see a CLTV based on weeks. For example:

Calculate predictive customer lifetime value in weeks

LimeLight’s Customer Lifetime Value Calculation

At LimeLight, we follow the calculation used most often for subscription businesses:

limelight customer lifetime value calculation

Getting fancy

There are two terms you need to know for this one. The first is discount rate, which refers to the interest rate used to find the present value of future cash flows. For most businesses, the discount rate is between 8-15%. The second is customer retention rate, which is calculated as follows:

calculate retention rate

With those out of the way, here’s how you calculate CLTV with a little more accuracy and specificity:

Calculate customer lifetime value advanced

Segmenting your customer lifetime value calculation

Depending on your business, a one-size fits all CLTV calculation may not be the right fit. If your customers fall into multiple subcategories, or segments, then you might find that your various customer segments need different lifetime value calculations. For example, many businesses have a set of customers who are brand-loyalists, buying regularly, but another set that will only ever purchase once, buying the specific product they were looking for, then never returning. Using one CLTV equation for both the loyalists and the one-time shoppers would give inaccurate results for both groups. The one-time visitors would appear to be worth more to the business than they are, while the loyalists would look less valuable.

Using different CLTV calculations is also wise if your business has multiple product lines that are very different from each other. If Carl’s Camera Co. sells both multi-thousand dollar DSLR cameras, and a $20/month online photography class, the customer bases for those two products would look very different, because both the average order values and the average customer lifetimes would be on totally different scales.

It goes without saying that segmentation doesn’t just apply to CLTV. We wrote all about segmentation: what makes it important, what defines a useful segment, the 8 questions segmentation can answer, and more.

Apply your CLTV knowledge

Once you calculate your customer lifetime value, what do you do with it?

CLTV is your guide to when you should and when you shouldn’t keep spending money on your customers. Simply put, your expenditures on customers shouldn’t outstrip the value your customers bring in. This helps you answer questions like:

  • How much of a discount (if any) should I give first-time customers?
  • Should I encourage my customer service reps to offer gift cards to inconvenienced customers? If so, how much?
  • Is the amount I’m spending on advertising per customer worth it?
  • Should I invest in my high CLTV customers by offering them more discounts and benefits?
  • Is it worth offering monetary incentives to recapture this customer whose visit frequency is decreasing?
  • Am I generating higher profit customers in one channel versus another?
  • Is one marketing tactic attracting a higher value customer than another?
  • How is my CLTV trending – Am I doing better this week than last week? If so, what did I do different to cause the increase/decrease?

Knowing your CLTV helps you spend your money intelligently, getting the most value out of your customers.

How to increase CLTV

Increasing your CLTV means more long-term profits for you, and if you’re doing it right, happier customers. The key is to increase how much your customers are spending, how long they keep coming back, or both. Your options include:

Increase the number of transactions

You want your customers to keep coming back for more! Consider remarketing programs such as weekly specials sent through email or actively engaging customers through social media to encourage customers to return and purchase, or membership programs (“get $Y off for every $X you spend at Carl’s Camera Co.”)

Increase average order value

Once again, membership programs are good at encouraging this, or “get $X off when you spend $Y” sales that apply to only one transaction. Bundling similar items together into packs is a great way to increase Average Order Value (AOV), as is proactively suggesting complimentary items (cross selling), suggesting a higher quantity of items at a reduced rate, or offering free shipping for orders over a certain dollar amount.

Decrease customer churn

Customer churn is no small battle to take on, but a good first step is investing in your customer service team. 70% of customers report leaving a business not because they were unsatisfied with the product, but because they were unsatisfied with customer service. Subscription businesses can also offer short exit surveys when customers cancel their membership, which can offer insight into why customers are leaving.

CLTV is an important part of every business’ toolbox, so do your budget a favor and make sure you don’t let it fall to the wayside. 

Want to learn more? Watch the video below to see what our Director of Analytics has to say about improving your CLTV.