The Formulas to Success: Calculating Customer Lifetime Value – Part 2

In the first part of our series we described exactly what customer lifetime value is, and how the top earning companies are using CLV to drive revenue. Customer lifetime value (CLV), in short, is your total expected gain from a single customer and it is one of the most important metrics to your business. Companies like Netflix and Starbucks are using CLV techniques that you can implement in your own business to create a long-term view of their customers to more economically acquire and retain them.

In part two of our CLV series we’ll be covering the three ways to calculate customer lifetime value. There are few variations on the formulas that we’ll be covering today, which range in complexity. Simply by taking the steps to knowing the value of your eCommerce customers you are separating yourself from the competition.

The 3 Ways to Calculate CLV

  • Simple and inexpensive – but not that accurate
  • Inexpensive and accurate – not that simple
  • Accurate and simple – a little expensive

Simple and Inexpensive

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CLV = AOV x APY x Profit Margin

Take Average Order Value multiply it by the Average Purchases per Year (=total number of purchases/total number of customers) multiplied by the Average Profit Margin. This is a really simple way to calculate, but only provides a rough approximation over a course of time. It still, may be “good enough” as a guideline for your budgetary or planning efforts. Adjustments can be made to help with your understand of how much you’re spending on ads and retention, for example the equation below, adjusted for any period, can quickly become inaccurate as you extend the model into the future:

CLV February 2016-06

Inexpensive and Accurate

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Calculating CLV can be inexpensive and very accurate, if you’re well-versed in mathematics. The above equation is an example of just how complex calculating CLV can get, but there’s goof reason for this. CLV equations are complicated because they include two very important things:

Average lifespan of a customer
How long a customer goes before they stop shopping with you. This is hard for you to calculate due to changes in shopper frequencies, but the right customer relationship management (CRM) tool will assist you in your efforts.

Lifespan of a customer, discount rate, and time value of money
Discount rate and the time value of money add to the complexity of calculating customer lifetime value. CLV will change over time, money is worth more now than it is in the future.

Simple and Accurate

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Services from various companies like Kissmetrics, Vantage Analytics, Custora, and RJMetric come into play here. These companies offer apps or guides that help you calculate these metrics on and on-going basis with a guide on which metrics to track based on your business.

Remember though, CLV won’t be that valuable to you if you aren’t calculating retention over time. For example you should be setting a timeframe like “year-over-year”. Only a very small group of your customers will become repeat customers, but don’t let that dishearten you. The value of that smaller group of repeat customers is exponentially more. You need to have the ability and willingness to adjust your marketing strategy accordingly to target these high value customer groups.

Aggregate or Per Customer Approach?

There are two ways you can calculate CLV; either on an aggregate or per- customer basis. Gone are the days though were casting a wide net to attract as many customers as possible is a strategy. Aggregate assigns a dollar amount to all your customers equally, and is much better suited for decision making for your physical retail locations but online you’ll need to:

Frame your profitability on a per-customer basis

This is where calculating customer value on a per-customer basis comes into play. Some customers will spend more, come back on a repeat basis, stay longer, etc., and will therefore be worth more to your business than others, impacting your strategic decisions in a big way. Next week we’ll cover how reap all the benefits of CLV at the per-customer level, sign-up below to be the first to receive our final CLV post.

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More resources to help you with calculating CLV if you’re interested: