Focus less on immediate profits, and more on cultivating healthy relationships with customers

Good business is a long game, and one of the most important indicators that you’re doing it right is your customer lifetime value (CLV). With it, you steer away from too much emphasis only on short-term (i.e. monthly or quarterly) profits, opting instead to focus on the long-term health of your customer relationships.

How long-term? That’s up to you. CLV is predictive, not absolute, and everyone will designate a different period of time. You might calculate it per year, five or ten year blocks, or even longer. Much of it will depend on the industry and nature of your business.

Customer lifetime value is defined as the financial value of each customer over the lifetime of your relationship with them. You might look at the historical CLV (total revenue up to that point minus the acquisition costs) or the predictive CLV (looking forward and applying patterns and assumptions about future revenue). The historical figure tells you how much a customer has been worth, while predictive tells you how much they might be worth moving forward.

Applying CLV

But why does knowing that matter? Understanding your average CLV (and the calculations presented here provide only a rough average — CLV can be an incredibly complex calculation if you want more precise stats and figures) provides you with spending guidance.

It can help to determine which marketing channels are most cost-effective at bringing in new customers. For instance, you can determine whether using a free website builder to deploy your professional website is better than paying more money to hire a designer and developer to build it for you.

In short, if you’re using multiple channels to build your customer base, you’ll want to know which one/s is/are providing the best return on investment. To do that, you compare the average cost of customer acquisition (amount spent on that channel / total number of new customers; often called the COCA) to the CLV for each new client. If the CLV is greater than the COCA, you’re making money and have a positive cash flow (again, we’re working only in rough estimates here).

If the CLV is less than the COCA, you’re operating at a loss for that channel, and you may want to consider abandoning it for more effective methods. That’s not automatically a bad thing, though, particularly if you have the funds to wait it out and increase the CLV over time.

Big companies will often operate or sell at an initial loss because they know the CLV will eventually increase. An example is the Kindle e-reader. Amazon sells them below or at cost as a customer acquisition avenue, knowing that individuals that purchase the device will be buying ebooks from them for years to come.

CLV can also help you determine which existing customers are driving your business and your revenue, as you’ll want to focus on those relationships and promote loyalty with them. It lets you know how much (if any) of a discount you can offer them and still operate in the black. It will also show which customers are draining time and money with very little return. Compare costs and CLV for a set period of time to get a “big picture” view of any relationship.

Also Read: 4 simple ways to cut your customer acquisition costs

Calculating CLV

The predictive CLV calculation requires a bit of educated guessing. It’s best to observe customer buying patterns for as long as possible, as you can then apply the patterns that emerge to similar demographics. Aim for specificity here (same age, gender, education, and so on for individuals, and same industry, size, budget, and so forth for companies) when applying these observed patterns.

The quick and dirty CLV equation is simply the average order value x the number of repeat orders x retention length.

A quick example:

Let’s say you have an online subscription service, and you’ve observed that customers in group A (similar characteristics) subscribe to the US$7/month plan for an average of 4 years. Your CLV is therefore calculated as US$7 (average order value) x 12 (repeat orders per year) x 4 (average retention length in years), which equals US$336.

Each new customer in this group has an average CLV of US$336. You could break that down into a yearly amount by dividing by four if you wanted to work with an annual figure (US$84/year in this case).

As long as you’re spending less than US$336 on each customer, you’re making a profit. If you acquire each new customer for less than US$84, you’re making a profit within the first year. If what you spend on acquiring and maintaining your customer relationships exceeds your CLV, you need to reevaluate your business model and marketing systems.

Also Read: How to find out what you’re exactly spending on customer acquisition

As predictive CLV calculations are just that – predicting – you’ll want to assess their validity frequently and tweak as necessary.

Increasing CLV

It is a long game, though. Don’t panic if your costs and CLV are close in the early stages. You can take active steps to increase it over time.
Work to increase the repeat purchase rate with loyalty programs or frequency discounts, for example.
Work to increase the average order value with bulk discounts, for example.
Provide phenomenal, otherworldly customer service to keep your existing customers happy and staying with you for a very long time. Long term customers spend money.
Upsell and promote your products and services.
Cross-promote other products and services via affiliate marketing.
Offer more than you expect in return. Matter outside of just when they need you by providing useful content for free, targeted messaging, suggestions, and recommendations. Become relevant to your customers in their daily lives.

Customer lifetime value is not an exact science, but it should be part of your professional tool belt. You want to increase it over time. You want it to be higher than the acquisition and maintenance costs for any given customer, and if it isn’t, you need to take steps to rebalance that. The equations and examples listed here will give you a decent ballpark estimate, but be aware that CLV often includes complicated data involving customer retention rates, customer churn rates, operating and production costs, discounts over time, and many other variables.

In business, it’s best to play the long game. Evaluate your customers over the length of their relationship with you via the customer lifetime value. Focus less on immediate profits, and more on cultivating healthy relationships with customers acquired through the most cost-effective channels.

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