Customer Lifetime Value is a metric that estimates the total revenue a business can expect from a single customer throughout their entire relationship. Customer Lifetime Value is also called “CLV,” “LTV,” “CLTV”, and customer equity.
CLV helps companies understand the long-term value of their customers, guiding decisions on marketing, sales, and customer retention strategies.
To calculate CLV, you need to determine the total revenue generated by a customer and subtract the costs associated with acquiring and serving that customer. The customer value formula is:
CLV=Customer Revenue−Cost of Acquiring and Serving the Customer
The importance of CLV lies in optimizing customer acquisition and retention costs, not just finding cheaper ways to acquire customers. As Michael Schrage highlights in “Who Do You Want Your Customer To Become?” improving customers makes them more valuable.
How to Calculate Customer Lifetime Value
Customer Lifetime Value Formula
The simplest customer value formula is:
CLV = customer revenue – the cost of acquiring and serving that customer
Let’s say that every year, for Mother’s Day, you send your mother the same $70 flower bouquet. If you’ve been doing this for the past five years, your lifetime value for your florist is $350.
However, this simple formula does not always apply, as most businesses are more complicated than that. So two other methods have been proposed: historical and predictive CLV.
Historical Customer Lifetime Value
The historical CLV is the sum of the gross profit from all historical purchases for an individual customer. This method shows the actual profit a customer brings to your store. To determine the historical CLV, first, you need to:
- Identify the touchpoints where your customer creates value;
- Integrate records and create a customer journey;
- Measure your revenue at each touchpoint;
- Add everything over the lifetime of that customer.
Then, you can use the formula below:
Historical CLV = (Transaction 1 + Transaction 2 + … + Last transaction) * Average gross margin
Let’s say a customer has made three significant transactions over their lifetime:
- Transaction 1: $100
- Transaction 2: $150
- Transaction 3: $200
The average gross margin for your products is 30%. To calculate the historical CLV, you sum the transactions and apply the gross margin:
Historical CLV=($100+$150+$200)×0.30=$135
This means the customer has contributed a gross profit of $135 over their entire purchasing history with your business.
The historical CLV takes into account customer service costs (cost of returns, acquisition costs, cost of marketing tools, etc.). The problem with this method is that it can be complicated to calculate on an individual basis, especially if you want the figures to be up to date constantly.
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Predictive Customer Lifetime Value
A more efficient way to determine the customer lifetime value is through predictive Customer Lifetime Value.
The predictive CLV is built based on predictive analysis and takes into account previous transactions plus various behavioral indicators that forecast the lifetime value of an individual. This value becomes more accurate with every purchase and interaction, so this is a better method to calculate customer lifetime value.
To calculate the predictive CLV, you need to:
- Identify the touchpoints where your customer creates value;
- Find out what determines that value and if it differs from customer to segment;
- Identify why a customer has moved from one moment to the next.
Then, you can determine the predictive CLV in two ways:
Simple predictive CLV:
CLV = (Average monthly transactions * Average order value) * Average gross margin * Average customer lifespan
*where the average customer lifespan is calculated in months. This formula is also used to determine the detailed predictive CLV, so let’s call it “CLVs.”
Suppose a customer makes an average of 2 transactions per month, with each transaction worth $50. The average gross margin is 40%, and the customer’s expected lifespan is 12 months. The predictive CLV is calculated as follows:
CLV=(2×$50)×0.40×12=$480
This predictive approach estimates that the customer will generate $480 in gross profit over their expected lifespan, providing a forward-looking view of customer value.
Detailed predictive CLV:
CLV = CLVs * Monthly retention rate + Monthly discount rate – Monthly retention rate
Building on the previous example, suppose we also have a monthly retention rate of 80% and a monthly discount rate of 5%. The detailed predictive CLV calculation is:
CLV=$480×0.80+0.05−0.80=$383.25
When calculating the predictive CLV, keep in mind that it will never be 100% accurate as this is just a forecast. However, if you personalize the formula for your business, you can determine a highly accurate customer lifetime value.
Also, note that the equations above don’t take into account the cost associated with retaining a customer. To get a net value for your CLV, you will also need to calculate this. And if you want to be accurate, you may also want to consider interaction and transactional information for each customer, as every individual is unique.
Customer Lifetime Value to Customer Acquisition Cost Ratio (CLV:CAC)
The ratio between CLV and Customer Acquisition cost (CAC) is one of the most important aspects a VC will look at before investing in your company. It is crucial for evaluating your business’s sustainability and attractiveness to investors.
You can’t acquire customers forever. So finding the right customer acquisition and retention mix is the key to sustainable eCommerce growth.
- Optimal Ratio: A good CLV ratio is around 3, indicating that your acquisition and retention efforts are well-balanced and efficient.
- Average Ratio: A ratio of 2 is acceptable but suggests there is room for improvement.
- Poor Ratio: A ratio below 2 indicates that either your business is spending too much on acquiring customers, or you are deliberately investing heavily to gain market share, which can lead to financial strain.
- If your ratio is above 3, it might mean you’re very good at acquiring and retaining customers. But it could also mean you’re being too cautious with growth or that your market is saturated and not expanding.
Why is CLV Important?
Measuring and tracking customer lifetime value is one of the most important actions you can take for your company. Here’s how CLV can guide you:
> Before wishing for repeat purchases in first-time buyers, learn how to encourage the second purchase.
Impact on the Bottom Line
Not all customers are profitable initially, but they can become top customers over time. Tracking CLV helps you optimize the customer journey, from acquisition to retention. Balancing CLV with acquisition and retention costs ensures positive impacts on your bottom line.
> See what it takes to acquire and retain profitable customers
Long-Term Loyalty
Understanding CLV across customer segments identifies your most valuable customers. Analyzing what drives loyalty allows you to refine your loyalty programs and offer VIP treatment to your best customers, strengthening your business against competitors.
Resource Allocation
The more value you generate from each customer, the more resources you can invest in retention, acquisition, and talent. This optimization leads to sustainable growth.
Rising Ad Costs
Ad costs, such as Facebook’s CPC, have surged, making customer acquisition more expensive. Knowing your Ideal Customer Profile helps train algorithms to acquire high-value customers, improving the efficiency of your ad spend.
Best-Performing Products
Your product assortment significantly impacts CLV. To improve it, focus on adding sticky products and eliminating those that cause churn. This requires collaboration across marketing, merchandising, and customer experience departments. Optimizing products and assortments can make your business more customer-centric.
Sustainable Growth
Relying solely on acquiring new customers who never return is unsustainable. A higher number of repeat customers increases CLV and ensures a steady cash flow. Monitoring the CLV to Customer Acquisition Cost (CAC) ratio allows you to optimize acquisition campaigns and focus on attracting loyal customers.
> Before wishing for repeat purchases in first-time buyers, learn how to encourage the second purchase.
Impact on the Bottom Line
Not all customers are profitable initially, but they can become top customers over time. Tracking CLV helps you optimize the customer journey, from acquisition to retention. Balancing CLV with acquisition and retention costs ensures positive impacts on your bottom line.
> See what it takes to acquire and retain profitable customers
Long-Term Loyalty
Understanding CLV across customer segments identifies your most valuable customers. Analyzing what drives loyalty allows you to refine your loyalty programs and offer VIP treatment to your best customers, strengthening your business against competitors.
Resource Allocation
The more value you generate from each customer, the more resources you can invest in retention, acquisition, and talent. This optimization leads to sustainable growth.
Rising Ad Costs
Ad costs, such as Facebook’s CPC, have surged, making customer acquisition more expensive. Knowing your Ideal Customer Profile helps train algorithms to acquire high-value customers, improving the efficiency of your ad spend.
Best-Performing Products
Your product assortment significantly impacts CLV. To improve it, focus on adding sticky products and eliminating those that cause churn. This requires collaboration across marketing, merchandising, and customer experience departments. Optimizing products and assortments can make your business more customer-centric.
> Discover the product optimization framework that helps you improve product assortment and become more customer-centric.
Investment and Loan Opportunities
A favorable CLV to CAC ratio is crucial for attracting investors and securing loans. It demonstrates efficient resource use in acquiring and retaining customers, making your business a more attractive investment.
Customer Lifetime Value Metrics
Understanding and tracking Customer Lifetime Value (CLV) involves analyzing several key metrics:
- Average Purchase Value (APV) is the average amount spent by a customer per purchase. To calculate APV, you divide the total revenue by the number of purchases.
- Purchase Frequency (PF) measures how often customers make purchases over a given period. It is calculated by dividing the number of purchases by the number of unique customers.
- Customer Lifespan (CL) represents the average duration a customer remains active before churning. To determine this, you sum the lifespans of all customers and divide by the number of customers.
- Gross Margin (GM) is the percentage of revenue that exceeds the cost of goods sold (COGS). It is calculated by subtracting COGS from total revenue and then dividing by total revenue.
- Customer Acquisition Cost (CAC) is the total cost of acquiring a new customer. This is calculated by dividing total acquisition costs by the number of new customers.
- Retention Rate (RR) measures the percentage of customers who continue to purchase over a specific period. It is calculated by taking the number of customers at the end of a period, subtracting the number of new customers acquired during that period, and dividing by the number of customers at the start of the period, then multiplying by 100.
- Churn Rate (CR) represents the percentage of customers who stop purchasing over a period. It is calculated by dividing the number of customers lost during the period by the number of customers at the start of the period, then multiplying by 100.
Customer Lifetime Value Benchmarks
After all the effort you put in to determine your CLV, you might also want to know where you stand compared to your competitors. Although each e-commerce business is different and their customer lifetime value varies, you can use benchmarks to estimate your position roughly.
If you want constant access to updated benchmarks, you can go to our free Real-time Customer Lifetime Value (CLV) Benchmark Report.
Industry Benchmarks
Let’s take a look at the historical Customer Lifetime Value by industry. At the end of 2021, data shows that stores in Home and Garden had the highest CLV, while Books and Literature had the lowest CLV. You can compare your CLV to the current average CLV in your industry right now by accessing our real-time CLV benchmark report.
Shop Age Benchmarks
The historical Customer Lifetime Value by shop age chart shows us that stores become more agile in retaining their customers in the long run as they gain more experience on the market. It’s the natural course of things: your CLV should get higher as your shop gets older.
Company Size Benchmarks
Looking at the historical Customer Lifetime Value by company size, it’s clear that CLV is an accurate predictor for sustainable growth. No matter how small or large your company is, you need to constantly measure, track, and improve CLV if you want to scale.
Customer Lifetime Value Examples
Example 1: Subscription-Based Online Store
Our first CLV example is from a subscription-based online store that uses REVEAL to calculate and monitor CLV and other key metrics.
The graph below shows the timeline representation of the historical customer lifetime value from November 2020 to November 2021. The company managed to increase the average CLV from USD 131 to USD 200. That’s an impressive improvement, and it happened because the company started to monitor CLV and the other KPIs with a major impact on CLV, like customer retention rate or the average purchase frequency rate.
source: REVEAL
Next, we have the same store’s historical CLV by RFM segment. When you combine the customer lifetime value model with the RFM segmentation, you can go more granular to identify the potential CLV growth sources.
The average CLV is higher in the “Soulmate” segment that includes the store’s most valuable and loyal customers, reaching USD 741. A company would want to attract more customers like the best ones considering the big difference between the CLV generated by the other groups.
source: REVEAL
Example 2: Fashion Retailer
In our second example of CLV, we have a fashion retailer. We analyzed the same period as in the previous example and we can see that the store managed to increase its historical CLV from USD 336 to USD 359.
source: REVEAL
The fashion retailer still has to work on its retention strategy and transform more customers into Soulmates. In the last 12 months, the average CLV of a Soulmate is USD 2123, which means that a Soulmate customer is six times more valuable than the average customer.
source: REVEAL
Once you start measuring and monitoring your CLV, you can start making significant changes in your company’s strategy that could be pivotal for your business. Keeping track of your CLV helps you spot future opportunities to improve customer loyalty, attract better new customers and prevent negative trends like customer churn.
How to Calculate CLV: Real-World Examples
If you’re interested in the thought process behind a CLV analysis, we’ve detailed it in this article: Customer Lifetime Value Analysis in Reveal vs. Excel.
1. Starbucks
Starbucks is constantly opening new stores around the world, and its acquisition strategy is frequently copied. For this case study, I am going to use data from 2004. The numbers do not reflect the company’s current status, but we can use them to exemplify how you should determine your customer lifetime value.
Step 1: Find out your average
To simplify calculations, let’s say you only have three customers:
- Customer 1 spends $4 per visit;
- Customer 2 spends $6 per visit;
- Customer 3 spends $9 per visit.
The average will be $6.33. I’ll call this value “s,” representing the average spend per customer.
For the purchase cycle, customer 1 visits you five times a week, customer 2 visits you three times a week, and customer 3 does it six times a week. The average number of visits is 4.66 (I’ll call this “c“).
Last but not least, your average customer value per week (expenditures* visits) is $20 for customer 1, $18 for customer 2, and $54 for customer 3. The average across the three customers is $30.66 (I’ll call this value “a“).
Step 2: Calculate the CLV
To determine the customer lifetime value, I will also use some constants:
Average customer lifespan (t) = how long an individual remains a customer. For Starbucks, that’s 20 years.
Customer retention rate (r) = the percentage of customers who repurchase over a given period compared to an equal preceding period. Starbucks’ retention rate is 75%.
Profit margin per customer (p) = For Starbucks, that’s 21.3%.
Rate of discount (i) = the interest rate used in discounted cash flow analysis to determine the present value of future cash flows. Usually, the rate of discount is between 8% and 15%. For Starbucks, it’s 10%.
Average gross margin per customer lifetime (m) = Starbucks has a profit margin of 21.3% (p). If the average customer spends $31.886 (52 * a * t) during their life as a customer (t), Starbucks has a gross margin per customer lifespan of $6.791 (profit margin * expected customer lifetime expenditure).
A large corporation like Starbucks will use several methods to determine customer lifetime value, marketing budgets, and acquisition costs.
2. Netflix
Determining your customer lifetime value is just the beginning. What you do with that information is what will determine your business’ success. Because now you know how much you should be spending to acquire a customer, from overhead to marketing. Let’s explore how Netflix uses CLV to shape its business strategy.
Maximizing profit
An average Netflix subscriber stays on board for 25 months and has a lifetime value of $291.25.
If you subscribe to Netflix right now, you would pay around $8.97 per month (that’s the cheapest price plan), which means $107.64 per year. If you were Netflix, would you spend $150 to acquire a customer? It seems counterintuitive to spend more to acquire a customer and still be profitable, but that’s why determining your customer’s lifetime value is essential.
Yes, Netflix would lose $42.36 in the first year, but as I mentioned earlier, the average Netflix user stays a customer for 25 months. So even if the company doesn’t make an immediate profit, it doesn’t mean it remains unprofitable. You shouldn’t be afraid to lose money in the short run if that can boost your revenue in the long run.
To determine how much you can afford to lose in the short run, you need to know the lifetime value of your customers. Without that number, it’s impossible to optimize your revenue.
Maximizing the customer’s lifetime value
Netflix tracks individual customer behaviors to optimize their CLV. For example, if a user stops watching movies, Netflix might proactively engage them to prevent cancellation. This personalized tracking reduces churn and increases the overall CLV.
Maximizing customer acquisition
Netflix knows their customer lifetime value and has fine-tuned their product to reduce customer churn so they can afford to spend more on marketing. For example, they pay affiliates $16 for every customer they bring in. It might not seem that much, but consider that Netflix offers the first month for free, and many users don’t turn into paying customers after that.
So, affiliates are paid $16 for each user, whether those users become profitable or not.
However, a percentage of those users do turn into paying customers. Otherwise, Netflix wouldn’t be able to keep paying affiliates $16 or spend $2 for every click from their Google AdWords campaign.
You can’t keep dumping money into marketing if you don’t know your lifetime value metrics well.
How to Improve Customer Lifetime Value
It’s cheaper to retain existing customers than to acquire new ones, especially in industries where the customer lifetime value is more important than the profit of an individual sale. Globally, the average cost of a lost customer is $243 (KISSmetrics).
64% of companies rate customer experience as the best tactic for improving customer lifetime value, followed by better use of data and personalization. There are many methods you can use to optimize your customer lifetime value, but here I will detail a few:
1. Treat your best customers differently
How would you call a world where everyone gets the same reward? Where everyone gets the same bonus, no matter how hard they work?
Unfair, right?
Well, that’s what happens if your eCommerce sends the exact special offers and discounts to all customers.
A good idea would be to incentivize customers to like you more by giving them unique treatments, ultimately increasing your chances of turning them into advocates.
That’s what Booking.com is doing with their best customers through their Genius program.
2. Offer a personalized experience
94% of businesses believe that personalization is critical to current and future success.
Let’s take a look at a case study we’ve made for Avon. The data on online surveys showed that the most significant barrier women had to buy from Avon was their distrust that the makeup would match their eyes color.
So, an actual beauty expert showed up on a triggered overlay to help them out:
The website displayed only relevant products for their eyes color, remaining consistent on the checkout:
3. Offer free returns
Free returns mean additional costs for you. But these costs need to be considered together with the extra conversions they bring and the potential to boost the retention rate.
However, to identify to whom you should offer free returns and optimize the type of products you are selling, you need to dive deep into data.
Did you know that… we empower eCommerce companies to monitor all these great metrics here at Omniconvert to help eCommerce websites extract this kind of data insights from their data. It is called Reveal, and it is a Customer Intelligence platform that’s already directly integrated with Shopify.
If you’re on a different platform, you can easily integrate it with any other platform – set up your account here>
Zappos found out that people who regularly return items are their best customers. Those Zappon clients who buy the most expensive products have an orders return rate of 50%.
“Our best customers have the highest returns rates, but they are also the ones that spend the most money with us and are our most profitable customers. – Craig Adkins of Zappos.
4. Address the reasons why orders are returned
For fashion e-commerce stores, size is one of the most frequent reasons items get returned. So many stores have implemented fitting tools and virtual wardrobes that makeup that customers cannot try on the clothes before buying.
Shoefitr, an app that helps online shoe shoppers find proper fitting footwear, managed to reduce the fit-related returns of an online footwear retailer by 23%.
Another example is GlassesUSA who lets its customers upload a picture of them and try on glasses before purchasing. And this strategy can be implemented for non-fashion-related online shops as well.
MyDeco 3D room planner is another tool that helps online shoppers try out room looks before buying furniture.
5. Provide multi-channel returns
The fit is not the only reason items are returned. Since customers will return products anyway, you should make their experience as easy as possible.
If you are an omnichannel retailer, allowing customers to return items bought online to brick and mortar stores is a must.
Customers appreciate the flexibility and convenience of multi-channel returns and are more likely to become loyal customers.
Think about it this way: when you allow your customers to return items in-store, you also take advantage of the opportunity to upsell or cross-sell. A well-thought multi-channel return strategy rarely lets customers leave the store empty-handed.
6. Focus on your ideal customers
The best-in-class retailers pay special attention to their VIPs by running RFM segmentation. RFM is a way to segment your customers according to their buying behaviors:
– Recency – How recent is the last order?
– Frequency – How often does that customer buy?
– Monetary value – What is the total revenue you got from each customer?
Find more about this model in this short video explainer:
Loyal customers are valuable, but loyal customers who also spend a lot of money with you are even more valuable.
Here are a few benefits you can offer them after you find out who they are:
- Priority Support
- Free returns
- Free delivery
- Tailor-made offers
- Packing and dispatching their orders first;
- Notifying them about new or limited products first;
- Sending them personalized lookbooks, exclusive previews, and presentations;
- Assigning them personal shopping assistants who can help them plan their wardrobes.
- Thank-you notes or gifts
If you are interested in understanding more about your buyer persona, read this article regarding how to do it. You will be able to optimize lifetime value and acquire the customers your eCommerce needs.
7. Provide outstanding customer service
A study by Zendesk revealed that consumers rank quality (88%) and customer service (72%) as the two biggest drivers of loyalty.
The same study also revealed that providing exceptional customer service 24/7 is the best way to build customer loyalty.
Measuring NPS or customer satisfaction or customer effort is an effortless way to stop broadcasting but establish a two-way communication model between you and your customers.
Moreover, if you mix RFM with NPS, you can reveal some hidden reasons why your CLV is being affected. Putting your customers first will not be an option soon. It will be a vital thing to do if you want your company to survive and thrive.
8. Acquire sticky customers
After identifying your ideal customer profile through RFM segmentation, you can improve customer acquisition by targeting customers who are more likely to buy again from you.
You may think that you can find this kind of demographic data in your Google Analytics or Facebook Insights. But, the truth is that what you are seeing there is the data regarding your visitors, not your customers.
And the customers are what matters to you. Moreover, your best customers (true lovers) are the ones you should focus your customer acquisition efforts on.
9. Build a subscription model
You may not have control over the delivery process, but you can still improve how the package looks like.
Birchbox, a company that offers monthly subscription boxes of cosmetic samples, delivers a personalized selection with a beautifully written letter in a branded box made out of Birch trees.
Another well-known retailer that invests in its packaging is Net-a-Porter. Many customers are so in love with their beautiful boxes that they can’t help posting their orders everywhere on social media (which, by the way, is an excellent method to increase customer loyalty and advocacy).
10. Diversify your product offering
As you can see, optimizing your customer lifetime value goes hand in hand with optimizing your retention rate. And the retention rate is improved when you make your customers’ lives easier.
If you identify the buying patterns of your most important customers, you can free them from the need to use other websites or channels to acquire the goods they need.
Uber is one of the companies that have diversified beautifully.
From the need to get a ride to the need to have food delivered to your door.
Optimize your Customer Lifetime Value strategy
Get more valuable customers for a more profitable e-store.
