What is Customer Lifetime Value and Why does it Matter?
If you own a business then you should understand customer lifetime value (CLV) and how much power it can give you when you are allocating resources and budgeting. Whether that's budgeting for marketing or deciding the next feature to build next in your app.
I didn’t go to school for business, I kind of just “fell” into it, or in-love with it, or was cursed with it. I’m not sure which is more accurate. Either way, when I discovered CLV I assumed that it was something every seasoned business owner was aware of and I was just late to the game. Through working with clients, I’m discovering that most don’ t actually know their CLV, how to figure it out, or what kind of decision making power it can give them.
When I first talk to a new client, one of the things that I try to find out is what their budget looks like. There are several things to consider when setting your budget, but a good first step is estimating the lifetime value of your customers.
What the heck is Customer Lifetime Value?
The CLV is how much revenue your average customer is estimated to bring to your business during your entire relationship with them. Not just the initial sale, but future purchases and subscriptions as well. By understanding this number, you’ ll understand how much you can spend to get them in the door (customer acquisition) and keep them there (customer retention).
How do I figure this out?
Well, I’m glad you asked. There are a few ways to get this and some are fairly complicated. For the sake of this post, let's keep it simple and and go through the “back of the napkin” approach.
Get your averages
For our simple math, let’s average things out so that we can see what a typical customer looks like financially to your business.
- Revenue per transaction: How much do they spend on average each time they buy something?
- Repeat transactions: How many times do they buy something?
- Retention: How long do they stay with your business before churning (going somewhere else)?
Example: Carl's Lawn Care:
- Average customer spends $100 per month for lawn care.
- Average customer uses Carl's for 10 months per year. (The other two they just let their neighbors judge them)
- Average customer uses Carl’s Lawn Care for 4 years before they find someone else to do it.
Crunch those Numbers
Using Carl’s averages, the simple math looks like this: $100 x 10 x 4 = $4000. Carl’s total revenue per customer is $4000. Let’s assume it costs Carl $30 per customer per month to run his business and maintain that customer. That’s $30-month, $300-year, or $1200 lifetime. Carl’s customer lifetime value is around $2800 (or $700 year).
What do these numbers tell us?
Knowing that Carl’s CLV is $2800 ($700 per year) means that as long as Carl spends less than $700 to get new customers, he will be profitable. (Obviously, we are not accounting for salaries and what not. We're keeping it simple, right?) When you want to market and grow your business, this is super helpful to know. And if you are throwing marketing dollars out there without this kind of information, you are shooting blind and just hoping for success.
Knowing his CLV, Carl can safely run a promotion for 2 months of free lawn care because he knows that he will still profit $440 that first year and $700 per year after that. Or he could budget a $9000 website project which could bring in a huge number of new customers because if it brings just four, then it's already paid for itself. Just think, what if his website helped bring in just 10 new customers? That’s an extra $40k in revenue and $19k in profit! I believe the technical term for this kind of ROI is… awesome.
A big reason that I ask my clients questions like this is because I want to make sure they are profitable. Helping my clients stay in business IS my business. Granted, like everything else in business, there’re no guarantees that something will work. But with staying on top of things like customer lifetime value, you are able to minimize your risk significantly and put your resources where they count the most.