How to calculate customer lifetime value

[Reyed Mia (Apprentice, DIU)]

How to calculate customer lifetime value

welcome to another episode of Weekly Marketing Tips. I'm Brad Batesole, and this week I'd like to talk about how to really identify the value of your customer. Your business has customers, but they're not all created equally. Some customers might purchase one product and leave, while others become loyal to your brand and purchase many products, over the course of a year, or two, or more. Which customer is then more valuable to you? Obviously the second group, but you need to be measuring lifetime value to know that, and to know if the audience you are attracting is increasing or decreasing that metric for your business.

This measurement is known as your CLV, or Customer lifetime value. Knowing your CLV lets you not only grow around the right audience, but it lets you know how much you can spend in advertising to acquire this customer. So to arrive at this number, we need some data. We need to know your average annual purchases per customer, the average profit per purchase, and the average number of years you keep a customer. Let's say you sell dog toys online, and you pull up your e-commerce data.

First, you might see that most of your customers have two transactions within your store, so they checked out twice in one year. You then see that the average order is $50, so each time they check out, you pocketed $50. But you know that your average markup is 50%, so you only profited $25 on that order. So now we know that each customer averages two transaction a year, each transaction profits $25, so each customer averages $50 in profit to the business per year.

Finally, you see that most of your customers typically stay engaged for another year, and that makes their retention rate about two years. So, let's plug all of the numbers together. Two transactions, times $25 profit, times two years, and this is going to be your customer lifetime value of $100. So that formula is average annual transactions, times average profit per transaction, times average years customers remain. With this, we can start leveraging the data.

We can work to retain the customers, so if they stick around another year, we make more money. Email marketing, sales, special offers, and so on could help move the needle. We can also try to increase the average transaction value by upselling or recommending other products. We can also use this number to help identify budgets for advertising. If a customer is worth $100 to us, how much are we willing to spend to acquire them? Perhaps we would spend $25 to bring in a customer. So for every $25 we spend, we profit $75.

So now you can start running paid ads, and work to optimize those to a cost per acquisition of $25. Take some time this week to calculate your customer lifetime value. It's an important metric to have on hand, and it's one you'll use quite often in your marketing endeavors.

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