How to Measure Customer Lifetime Value

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Retaining customers should always be the main goal of any company. While gaining new customers is also important, constantly searching for new clients can leave your company without a solid foundation to stand on. Loyal customers offer a constant revenue stream, which can help your company make better financial decisions.

You can even calculate customer lifetime value, which you can use to compare the cost of finding new customers and retaining older ones. We will go over all of the formulas that you can use to measure these metrics effectively.

What Is Customer Lifetime Value?

It refers to the total money a customer will spend with the company throughout their relationship. So the longer the relationship with the business, the higher their customer lifetime value. Companies will use this value for a range of analytical and marketing needs, which usually include promotional efforts, retention efforts, and one of the two they should focus on.

The Models for Customer Lifetime Value

We will go into depth about the different formulas you can use to determine the customer lifetime value and its surrounding metrics. However, all of those formulas are only useful when you’re using them with a model in mind. We will go over two very popular models, each using different metrics to calculate more detailed customer lifetime value. These include:

Predictive Customer Lifetime Value

Predictive Customer Lifetime Value is the model that focuses on predicting the buying patterns and behaviors of both new and existing customers. It is easily one of the most effective ways to tell just how valuable a possible customer is. Since the model uses existing data to predict if a customer will be spending more money in the company, it is a good way for businesses to find out who their loyal customers are.

The predictive customer lifetime value also allows you to identify the service or product responsible for bringing in the most customers. That information can later be helpful when they are trying to determine the best promotional approach to take. Finally, this model can help you improve customer retention by focusing on customers who are less likely to stay.

Historical Customer Lifetime Value

Unlike the predictive customer lifetime value model, the historic one uses past data. Using this past data, you will be determining the customer’s future value, regardless of whether or not they stay with the company. Using the average value of orders, you can calculate your customer’s value.

However, this is not a very effective tool to use when trying to determine long-term customers. This is best for customers who will only be active for a short time.

Even though this model uses historical data, it can have some issues. It can sometimes consider a customer active, who might become inactive soon after. Therefore, the data you can calculate might become inaccurate.

Simultaneously, some customers might return after being inactive, but you will not be able to add them to the model, seeing how you have already labeled them inactive.

Measuring Simple Customer Lifetime Value

There are multiple ways to calculate customer lifetime value, with all of them helping with a specific part of customer segmentation or retention. The simplest way to calculate customer lifetime value is by first determining the average retention time in years, average purchases in years, and average order total. Once you can find these values, simply multiply them together.

So average retention time x average purchases x average orders = average customer lifetime value. You have determined using existing data.

Other necessary formulas include:

Average customer Lifespan
The sum of customer lifespans / number of customers

Customer Value
Average purchase frequency x Average purchase value

Average purchase frequency rate
Total purchases / total customers

Average purchase value
Total revenue / number of orders

Ways to Increase Customer Lifetime Value

Increase Order Value

One of the fastest ways to increase customer lifetime value is by increasing the order value. Before the customer is about to check out, suggest other products that would work with their current one. Amazon does this with their “frequently bought together” section, suggesting other goods that would complement their current product.

Build a Long-Lasting Relationship

Crafting long-lasting relationships with your customers can be very satisfying, as it takes a lot of work to build that trust. Offering them unique discounts, free shipping, convince, and high quality, they will come back. And every time that they receive a good service from you, the likelihood that they will come back increases, and then coming back to you becomes a guarantee.

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