What is Customer Lifetime Value?
Customer Lifetime Value is simply the total revenue made over a customer’s lifetime. The calculation is (Average Value of a Sale) X (Number of Repeat Transactions) X (Average Retention Time in Months or Years).
This can be really easy or very complicated to calculate based on your product/service and the anomalies in your customer’s purchasing habits. A monthly subscription service with 100 customers that pay $20 a month is much easier and a more accurate calculation than a retail store with multiple products and a wide range of customers.
This is a crucial metric to understand as it sets the basis for how much you can spend to acquire a customer. You always want to make sure your customer lifetime value is at least three times more than how much you spend acquiring them in the first place. This ultimately helps in looking at your long term customer acquisition efforts versus the short term. Starbucks doesn’t focus on the $5 coffee purchase, they focus on the $15,000 which is roughly their customer lifetime value. A CLTV of $15000 is quite a lot and explains why Starbucks spends so much on creating a habit forming environment and products like free wifi, comfy couches, and a rewards card. This is to ensure the likelihood and frequency of purchases.
Another example of CLTV in action is gym memberships. Have you ever been offered $1 deal to join a gym or 1 month free, if you sign up for a year? You may wonder, how does the gym make money if they are giving memberships away for free? Easy, the long term customer lifetime value adds up to Membership Fee X 12 months X 1 year. If that amount is $600 ($50/month), then losing $50 upfront is certainly affordable.
Next week, we’ll talk about strategies on how to increase your CLTV. Tell us, do you know how to calculate your CLTV?