Customer Lifetime Value (CLTV), or Customer Lifetime Value (CLV), predicts the total revenue a company will generate from a customer.
Customer lifetime value measures the total revenue a business can expect from a single customer account. It considers the customer’s revenue value and compares that to the company’s predicted customer lifespan. Businesses use this metric to identify significant customer segments that are the most valuable to the company.
Formula for customer lifetime value
The formula for calculating customer lifetime value varies depending on the business model and industry. However, a basic formula is:
CLTV = (Average Purchase Value x Purchase Frequency) x Average Customer Lifespan
Calculate average purchase value by dividing the company’s total revenue in a time period (usually one year) by the number of purchases over that same period.
For purchase frequency, divide the number of purchases over a period by the number of unique customers who made purchases.
Meanwhile, to calculate average customer lifespan, take the average number of years a customer continues purchasing from the company.
To interpret the CLTV, businesses must understand its relation to Customer Acquisition Cost (CAC). Having a CLTV that’s higher than the CAC means the company is in a healthy position. This is because the customer’s value exceeds the cost businesses spend to acquire them.
Importance of CLTV for Subscription Businesses
In subscription businesses, CLTV is crucial. These companies spend significant resources upfront to acquire new customers. Therefore, they expect that the cost will be offset by the revenue generated over the customer’s lifetime. If the CLTV is low, the business may not recoup its initial investment.
Subscription businesses focus on providing extended value to customers as a core part of their business model. This is because the more value a customer receives, the longer they are likely to remain a customer, and the less likely they are to churn. This extended delivery of value thereby will increase their lifespan. Customers who perceive (and receive) high value from a subscription or other digital business model are also more likely to make frequent purchases, increasing their purchase frequency. Both of these contribute to an increased CLTV.
Moreover, a high CLTV allows subscription businesses to invest more in acquiring new customers. This will grow their customer base and increase overall profits. Businesses gain a variety of benefits by focusing on improving their service or product to increase CLTV. They will enhance customer satisfaction, increase customer retention, and improve their bottom line.
In conclusion, customer lifetime value is a vital metric for businesses to understand their customers’ value over time. It can guide strategic decisions about sales, marketing, product development, and customer support. For subscription businesses that focus on long-term customer relationships, understanding and improving CLTV can lead to significant increases in profitability.