Every marketer knows that success can be measured. The question is simply how to measure it.
Some marketers claim that the break-even analysis is the perfect identifier of profitability and sustainable growth. Others claim that year-to-year trend analysis is best. Still others prefer alternate miscellaneous data points.
There are so many difference ways to measure success, how can you know which metric is the most accurate and most useful?
For decades, major corporations have been using customer lifetime value (CLV) as a primary marketing measurement.
While they do track a wide variety of other measures, customer lifetime value is at the top of the list. Only recently have smaller businesses began to realize the power of this important metric.
So what is customer lifetime value and what does it tell you? In a few words, it is the total amount of money that a typical customer will spend on your brand over the course of the customer’s life.
Knowing the exact amount of money that a customers is going to spend on your brand is better than gold.
It can help businesses refine their marketing efforts, control marketing costs and predict a precise return for every marketing dollar spent.
Benefits of Customer Lifetime Value
With a metric as powerful as customer lifetime value, it is almost impossible to list every single benefit so we are going to talk about the biggest ones. You might think of a few others to add to the list, but let’s start with these.
- Asset Valuation -There is normally one major asset that is not included in annual reports and that is a company’s customer base. Each year, more company’s are waking up to the fact that their customer base is their largest asset. This is not to be confused with the company’s greatest asset: its employees. Most companies have more money invested in their customers than in any other asset whether it’s property, patents or contracts. Putting a clear dollar value on your customer base and recognizing customers as an asset makes it easier to use customer data when making decisions. And that’s really the point behind asset valuation, to be able to use measurements to make better decisions. Many companies are facing that very problem. They don’t know how to use customer data because they don’t realize that customers are a measurable asset with a real dollar value.
- Setting Goals - Most businesses set goals based on yearly projections that focus solely on increasing immediate profits. This is usually done through increasing sales instead of cutting costs. What these businesses don’t know is that these sudden spikes in sales can effect the long-term buying habits of their customers. If a typical customer is only going to spend a certain amount on your brand, why kill the golden goose? Too many companies are wanting all that money now and are pursuing their customers harder than ever. Instead, why not consider a different goal. That goal should be to grow your customer lifetime value. If you can get your typical customer to increase the total amount he or she is going to spend on your brand, you will see an immediate and sustainable increase sales and profits. I’m not talking about extending the life of the customer which should be another goal. I’m talking about getting them to spend more on your brand during the time that they are active customers. This will provide the sales spike you need without changing the long-term buying habits of your customers. This differs from traditional sales spikes in that it focuses on changing the mindset of your customer. You have to change the conversation. Focus on brand awareness and recognition. Build a long-term relationship instead of hard selling. It is actually very easy to do and very rewarding when done correctly.
- Alternative Marketing Strategies - Most marketing strategies focus solely on new customer acquisition. While this is a vital part of marketing, it is often over-emphasized because of the customer turnover that many companies suffer from. These companies have great strategies for attracting new customers but no strategy for keeping them. Repeat customers are the ones that are going to spend the most on your brand so it just makes sense to create as many of them as possible. Instead of spending money attracting one-time customers who buy something and then move on, sink some of that cash into retention programs designed to extend the lifespan of your customers. This is the natural progression in setting goals designed to increase customer lifetime value as mentioned in the previous point above. And for those that don’t know, the average life of a customer is the amount of time that a typical person will spend as an active customer. We are not referring to the actual life expectancy of that person. While you will always want some marketing effort targeting new customer acquisition, the majority of your efforts should focus on customer retention.
- Segmenting Customers - The first thing every smart marketer does is segment customers by demographic. This is one of the oldest and most reliable marketing metrics. However, how valuable is demographic information if you don’t have an exact dollar value for each demographic? Demographic information is useful in that it tells you which demographic fits your market better than other demographics and that’s it. In other words, it’s relative. It doesn’t tell you how successful you are going to be in any market. It only tells you which demographic is relatively better when compared to other demographics. By calculating the customer lifetime value of each demographic segment, you can determine exactly which ones are spending money and which one’s aren’t. In addition, you will also know exactly how much money each individual customer within that demographic is spending. That is powerful information to have. You will be able to determine exactly how much money you need to spend on each demographic to get the maximum returns and exactly what those maximum returns will be.
There are so many benefits that come with customer lifetime value that I just can’t list them all. These are few to help you get started.
As you think of other ways to use customer information, consider how those decisions will affect the long-term buying habits of your customers and the total amount that a typical customer will spend on your brand over the course of his or her life.
Calculating Customer Lifetime Value
In order to reap the benefits, we must suffer a little pain. That’s a popular saying in the locker rooms of many sport’s teams. That should also be the slogan of every marketing department.
Calculating and interpreting metrics is not easy. Sometimes it’s more difficult than it really should be. Of course there are tools and software that we can use to calculate the numbers but that doesn’t help with interpreting what those numbers mean. It can be down-right painful sometimes when dealing with measures and metrics.
That is, until we start using customer lifetime value.
Customer lifetime value is one of the easiest measures to calculate and interpret. Interpreting is really easy. The higher the number, the better. Calculating is almost that easy. There are only four things that go into figure out how much money a typical customer will spend over the course of his or her life.
- Average Customer Expenditures per Visit - This is the average amount that a typical customer spends each time he or she makes a purchase. Some customers will spend more than other so we use the average. You can calculate this number by taking your annual gross sales and dividing it by the total number of customer visits for that year. This will give you the average expenditures per visit for that year. Most accounting software can query this information in just a few minutes. For our example, we will give this a value of $12.73 per visit.
- Average Customer Visits per Week - This is known as the purchase cycle. It is the average number of times a typical customer will purchase from you in any given week. Some customers will visit more than others so we will use the average. You can calculate this number by taking the total number of customer visits per week and dividing it by the total number of customers that visited that week. Again, most accounting software can query this information for you. For our example, we will give this a value of 3 visits per week.
- Average Customer Value per Week - This is the amount that a typical customer will spend each and every week on your brand. We will use the two numbers that we just calculated above. Take the average customer expenditures per visit and multiple that times the average customer visits per week. For our example, we will call this variable a and will have a value of $38.19 per week as calculated using the variables above.
- Lifespan of Customer - This is the total number of years that a typical personal will remain an active customer of your brand. Each business has a different lifespan of customer. For our example, let’s call this variable t and give it a value of 15 years.
Using the variables above, we calculate customer lifetime value like this:
52(a) Χ t
Yeah, it really is that simple. Take average customer value per week (value a) and multiply it by 52 weeks to get an annual value. Then multiply that number by the lifespan of customer (value t) to get customer lifetime value. In practice it would look like this (using the values assigned above):
52($38.19) Χ 15 = $29,788.20
That’s 52 weeks per year multiplied by $38.19 per week. That total is then multiplied by 15 years which gives your $29,788.20 spent on your brand by a typical customer over the course of his or her life.
This is the easiest and most straight forward method for calculating customer lifetime value. There are other methods that are more complicated and potentially more accurate.
However, those methods are best reserved for corporate conglomerates with scores of accountants and statisticians whose sole purpose is to calculate metrics.But for startups and small business, this method is the best to use.
Using customer lifetime value is the best measure for successful marketing campaigns.