No matter what industry you serve, there are few metrics that every business must be aware of. Obviously, every business must be aware of their expenses and revenues, but how do these figures compare to the number of returning customers?
Customer lifetime value is the amount of profit that can be expected from the average customer. While this is only a projection, it can help assess the vitality of a company’s business model. In order to calculate customer lifetime value, one must answer the following questions by making educated assumptions:
- What is the value of the average sale?
- How frequently does the average customer repeat purchase?
- What is the average duration a customer will remain loyal to the business?
Multiplying the above assumptions together will help the expected lifetime revenue. In order to calculate the expected profit from a single customer, you must multiply the result by the profit margin. The profit margin will take overhead expenses into consideration, otherwise, the lifetime value figure could be misleading.
For example, let’s assume the average sale for a retail store is $50 and their customer’s return to shop once every 3 months, over the course of 5 years on average. Calculating lifetime value as $50 x 3 x 5 would equal $750.
The operators of this retail shop might assume, they can spend up to $750 on customer acquisition costs like marketing and advertising. Understanding that it would behoove the store owners to run an elaborate marketing campaign, they decide to run an ad in an industry magazine for $2,000.
Although the magazine advertisement only brought in 10 new customers, the operators argue it was still successful, understanding they will recoup their investment with a CLV of $750 per customer.
Unfortunately, they forgot to consider profit margins. After overhead expenses like rent, utilities, and payroll the profit margins are only 20%. This means that instead of a $750 CLV, the retail store only profits on 20% of that, $150. Now the $2,000 advertisement becomes a losing proposition.
To help businesses further understand, CleverTap has created the visual below to include the calculation, examples, and tips to optimize customer lifetime value.