CLV | One Marketing Metric to Rule Them All
Learn how to leverage the one metric at the heart of every successful marketing strategy
If Customer Lifetime Value does not sit at the core of your marketing strategy you may be on a fast track to disaster.
If there was ever a top ten list in a game of marketing bingo, “what’s my budget?” would be vying for the top spot.
But despite the popularity of this plea, no successful marketing campaign ever set out to simply spend a budget.
Marketing is about customer creation. It’s about identifying and meeting needs and facilitating the purchase process.
So successful marketing isn’t about spending cash, it’s about creating it.
A customer is an asset that keeps on giving, so the first question in any marketing strategy is about the value of your new acquisition.
Once you know what an asset is worth, only then you can go about deciding how much you’re prepared to spend to secure it.
Customer Lifetime Value
Customer Lifetime Value (or CLV for short) is the net forward profit from a customer over the period that they’re prepared to keep on buying from you.
It’s the single most important metric we use to establish the value of a customer.
It’s derived from the total investment they make (from initial purchase, subscriptions or value-added services) less the cost of service to deliver it (manufacturing, distribution and customer care).
It’s modified by the fact that a dollar next year simply isn’t worth as much to you now as a dollar today, so we must discount that future profit to understand its real value.
And more importantly it sets a hard limit on what you can spend to acquire them.
If the cost of your customer acquisition exceeds their lifetime value, then you have just established a platform for failure.
In other words, it’s not your company that sets your budget – it’s your customer!
Putting CLV at the heart of your marketing decision-making does far more that simply set a budget and drive profitability, it alters the entire attitude to customer relationships and engagement:
- It establishes from the outset that the customer is central to your proposition
- It defines the customer as an asset to be acquired and maintained
- It provides incentive to focus on the most valuable customers
- It encourages your business to focus on long-term relationships
- It defines the return on investment of your product and service portfolio
- It holds marketing channels accountable and prioritises for growth
- It provides a success metric to judge organisational performance
- It monitors the impact of business strategy
Defining, establishing and sharing CLV metrics throughout an organisation creates a platform on which to establish not only marketing capability, but also its contribution to the overall business growth
Setting a Foundation
Tracking CLV is critical for your business, but it's fairly easy to establish. Comfortingly, there are very few metrics involved.
You may need to make a few broad assumptions at the start, but usually existing companies have information in place, and new companies can make reasonable forecasts about what they intend to achieve.
Typical metrics are:
- The time period for calculation
- Average purchase value in that period
- Average service cost in that period
- Customer retention rate between time periods
- The discount rate across that time period
Often a simple record of annual billings to date will form the basis for that data, but in more complex industries, you may need to indulge in a customer survey.
Modern digital environments provide very detailed reports from online retailers that can specify the numbers you need through simple reports.
Where you’ve got a gap in your data, take your best guess. Just make sure you can explain the assumptions you’ve made.
Remember – the real benefits in calculating CLV in terms of marketing are derived from customer segmentation. The more you can segregate the behaviours and buying habits of different types of customer, the more useful the data becomes.
You can download our FREE template here: CLV Project Calculator
Creating a Baseline
Although calculating CLV can seem a daunting prospect, the figures involved are straightforward to identify:
Time Window / Period
A typical business may retain customers for 3 – 5 years and budget annually, so it’s not unreasonable to set your overall window to 5 years, and your assessment period to one year.
However, seasonal business, or short-term concepts like mobile apps or pop-up restaurants may only last 12 months, so monthly periods might be more appropriate.
Alternative models may be based on product lifecycles, particularly when the customer may transition through stages over time. For example baby care companies have different stages through pregnancy, infanthood and young children so they may choose these as their time periods.
Average Customer Spend
This is calculated specifically for the time period involved (i.e. on a monthly or annual basis) and may involve multiple purchases – it’s the total spend within the specific time period that counts.
This is the (Total Sales Revenue) / (Total Customers Who Bought in the Time Period)
Average Product and Service Cost
This involves all costs within the time period that were involved in service delivery – including the costs of manufacture and distribution.
This is the (Total Business Cost excluding Marketing) / (Total Customers Who Bought in the Time Period)
This includes marketing costs in that period that were based on maintaining existing customer care and engagement, but not those involved in customer acquisition.
This is the (Total Marketing Cost excluding New Customer Acquisition Spend) / (Total Customers Who Bought in the Time Period)
This is the average percentage of your customers that continued to buy products from you between any given time period and the next.
This is the (Total Customers Who Bought in The Last Time Period and Also Bought in Previous Time Period) / (Total Customers Who Bought in Previous Time Period)
Another term for this is ‘cost of capital’. It can be defined as ‘the required rate of return’ from an investment in your company.
It’s usually specified by your finance director (or investors), and whilst it could be a general annual interest rate, it will also be affected by several factors:
- Inflation reducing the value of future income
- The opportunity cost of being unable to spend the money elsewhere
- The risk that your business may not be profitable
Your finance director (or investors) may have this figure already, or you can take a guess – 10% annually (0.79% monthly) is usually regarded as a conservative figure. If you suggest lower, it will assume your business is very reliable, if you go higher, it will assume your business is risky.
Case Study for Calculating CLV
We’ve created a simple case study to illustrate CLV in action.
Remember, you can download our FREE template here: CLV Project Calculator
- We’ve looked at annual expenditure over a 10-year window.
- We’ve assumed that we retain 60% in the first year, but our retention of those customers gradually increases because customers who have stuck around in the past tend to stick around in the future!
- The final retained customer base per year is what’s left from the Year 1 customers as we apply those retention percentages across the whole window. This becomes the probability of the customer still existing over time.
- We can calculate that with those retention rates a customer sticks around on average for only 2.7 years. That’s a good metric to follow in the future…
- We assume that the average customer spends $300 per year, but that amount gradually increases because customers who have stuck around tend to spend more!
- The adjusted revenue is the annual expenditure multiplied by the probability of the customer still be retained.
In this example we get our first shock: many entrepreneurs assume that a customer spending $300 a year will be worth $3,000 over 10 years, but in reality the probability of losing customers means that the actual lifetime average spend is barely a quarter of that!
- The product and service cost in our example is about half of the sale price starting at $150. This will vary dramatically between different businesses.
- The marketing cost of $50 is the money we are spending on marketing to existing customers with our customer care centres and regular correspondence.
- The adjusted cost is the annual cost multiplied by the probability of the customer still be retained.
- The average customer profit per year is – you guessed it – the spend less the costs.
- The adjusted profit is the annual profit multiplied by the probability of the customer still be retained.
- This discount rate is set a conservative 10%
- The discounted profit is the annual profit less the cumulative discount rate.
The feedback from the exercise illustrates an important business point: that the ‘real’ value of a customer today (the profit that you will generate from them in the future) is often far less than people expect.
Think back to that ambitious first estimate of $3,000 spend per customer over 10 years, and now we can see that it's actually only worth $239 in profit.
A retention rate of 60% is a fairly good business standard, but even so it means that by the time you finish Year 3, you may have lost two thirds of them.
The entire ‘profit’ from a customer is a small proportion of their revenue. If you spend too much of that on customer acquisition, your business is in danger.
The outcome specifies in quantitative terms three very clear messages...
- Maximise your customer retention
- Maximise your product value
- Minimise your costs
... the ‘profit’ available to spend on customer acquisition will make or break your business.
Setting Project Targets and ROI
When setting marketing project targets, CLV is critical.
Your Customer Lifetime Value becomes the maximum you can spend on acquiring a customer before your business heads into a loss.
Wherever possible, calculate your CLV for the specific customers you are targeting with your project - it will demonstrate how some customers are worth more than others.
In this project example here we have established a few hypothetical (but not unusual) costs for a marketing project:
- We expect to spend $9,000 on external fees like creative work and media spend
- We expect to spend around $1,000 on internal man hours to support it
- We anticipate acquiring 50 new customers as a result
As you can see, the eventual cost per new customer acquisition ends up at $200 – dangerously close to the entire profit ($239) we can make from any customers we acquire.
We can also calculate this figure as a return on marketing investment (both before and after discounting for the future value of money).
Small variations in your effectiveness can result in the number of new customers acquired going down, the cost of acquisition going up, and the entire project running dangerously into losses.
Comparing Opportunities with IRR
With the combination of an average CLV benchmark figure, and estimated project costs, we can establish a single number that allows us to compare one project with the next.
It's called the 'Internal Rate of Return' (IRR), and conceptually it's similar to the interest rate you would be getting on your marketing investment if you put it into a savings account.
However, just like an interest rate, it doesn't take into account the discount rate (how that future money is devalued).
Nevertheless, it's a valid point of comparison, and should give you a very clear idea of the benefits you may derive by choosing one project over another.
Just as with any marketing concept, the easiest way to learn is to simply get going.
We've provided an editable template to help you make all the necessary calculations for your own business - so at the very least, you can jump straight in and start playing with the numbers to see what happens.
There is no better time than right now!