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Why does customer lifetime value matter?

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Why does customer lifetime value matter?

January 21, 2020

The lifetime value of a customer is inherently important for any business. By retaining customers over long periods of time, you can increase their lifetime value and, therefore, your business turnover. For businesses that operate on a subscription model, customer lifetime value is extremely important. With your turnover and profit resting on the user’s willingness to continue engaging with your brand, it’s vital that customer lifetime values are optimized wherever possible.

What is customer lifetime value?

Customer lifetime value, or CLV, is essentially how much a customer is worth to your business across their user lifespan. As one of the most important metrics for your business, it’s essential to calculate the lifetime value of users. Once you have the information, it will be a key factor in many of the decisions you face. 

When you can accurately predict customer lifetime value, you can also build data models to identify your expected income, turnover, and profits. This data is extremely important for your business and will be used to make some of the most important decisions you face. Management will often use the figures generated based on CLV to attract investors, obtain external funding and plan business growth, for example.

How do you calculate customer lifetime value?

Calculating CLV can be tricky as there are many different methodologies to choose from. For subscription-based businesses, however, there is a relatively simple way of calculating basic customer lifetime value. 

This involves identifying the profit you make from a customer every billing period. If you charge $50 for your subscription service every month and $10 of this is profit, for example, every customer has a monthly value of $10. If you have 1,000 subscribers, this equates to $10,000 profit every month.

To calculate the lifetime value, however, you need to know how long your users continue to be customers for. The number of customers you lose every month is known as your churn rate. If your churn rate is 5%, for example, this equates to an average customer lifetime of 20 months. If you multiply their monthly value ($10) by their expected lifetime (20 months), you realize that their customer lifetime value is approximately $200. 

Using this methodology, it’s easy to see how customer lifetime value works. In the example above, the CLV of $200 is how much the user will spend with your firm whilst they remain a customer. However, there are various ways to calculate CLV and you may want to adopt a more advanced approach. 

If you have different customer bases, for example, you may want to calculate the CLV of business customers and consumers separately. Similarly, assessing the CLV of different demographics can tell you which segment of your customer base makes up the biggest proportion of your churn rate. With endless possibilities, calculating customer lifetime values gives you a considerable insight into your business finances and user behaviour. 

Is customer lifetime value important?

Yes. There are few metrics that are as important as CLV. Due to this, it’s important to calculate customer lifetime value accurately and on a regular basis. As a subscription-based business, your financial stability is based on retaining customers. If you fail to do this, you aren’t going to generate the turnover or profit you need to keep operating. By calculating CLV, you can get a clear idea of how long you can rely on users to generate income for and how much they’re likely to generate. This enables you to plan for the future and make business decisions accordingly.

However, knowing your customers’ lifetime value has other advantages too. When you calculate CLV, it gives you the data you need to calculate customer acquisition cost (CAC) too. This is how much it costs you to acquire every new customer and it should play a significant role in calculating your marketing budget.

If your CLV is $200, for example, a CAC of $150 drastically reduces the profit you’re making. If you can achieve a CLV of $200 with a CAC of $20, however, you’re making a much larger profit per customer. Once you know your CLV, you can determine what an acceptable CAC is for your business. This gives you a clear indication of what you should be spending on marketing and encourages you not to put too much of your resources into attracting customers that offer a relatively small CLV. 

While many businesses focus on the importance of getting new customers to sign up at any cost, CLV shows that this isn’t always the best approach to take. By keeping your CLV at the forefront of your mind, it’s easy to determine the resources you should be allocating to acquiring and retaining customers.

Maximizing customer lifetime value

Maximizing customer lifetime value

If you can increase your CLV, you’ll naturally boost your profits. There are two approaches you can take when maximizing CLV. Firstly, you can focus on increasing the monthly revenue each customer brings in. If you can reduce your costs, for example, a customer’s monthly value might increase from $10 to $15, which enhances their CLV. Alternatively, you might want to focus on encouraging your customers to sign up for a more expensive subscription plan by offering premium features, such as better customer service and enhanced usage rights. If customers pay more each billing period without your costs being increased, more profit made each month and the CLV increases accordingly.

Secondly, you can maximize CLV by increasing the lifespan of each customer. By reducing the churn rate, you are retaining your customers for longer and increasing their lifetime value. Of course, the nature of the subscription economy means that increasing the monthly value of a customer and lengthening their lifespan would give you the best results in terms of CLV. 

With so many benefits associated with knowing your customer lifetime value, it’s easy to see why this metric is so important to businesses. Giving you access to crucial data and user behavior patterns, CLV can and should have a significant impact on how you run your company.



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