What is Customer Lifetime Value (CLTV), Importance & Calculation of LTV

Customer Lifetime Value is an important business metric that measures how much a business can earn from average customers over time. Cost, product differences, and purchase frequencies can make the calculation of customer lifetime value a bit complicated. You can conveniently calculate in just a few minutes by using the right tools and methods.

Understanding the LTV of customers is imperative to planning marketing and sales strategies. Measuring LTV gives an insight into the total customer value throughout the relationship. Today’s blog will guide you through the process of understanding Customer Lifetime Value, the importance of adopting this tool, and the basic calculation process of this metric.

LTV of a customer, importance, and how to calculate

What is Customer Lifetime Value?

Customer Lifetime Value measures the total income a business can earn from the customers as long as they remain loyal customers. While calculating Customer Lifetime Value, it is ideal to look at the average revenue generated by the clients and the total average profit. This measure gives you crucial insight into how your customers interact with your business and whether your marketing plans are working as expected.

If you want to have a detailed look at the income generated, break the lifetime value of your customers into small segments. You can get an in-depth understanding of the working of sales strategies with high-value clients. This will help you enlarge these strategies successfully working to your overall customer base.

Customer Lifetime Value Example

Importance of Customer Lifetime Value

Customer Lifetime Value is considered to be an essential tool for all businesses working on increasing the value of existing customers. But why is this so important? Let’s find out the reasons behind using CLTV.

● As soon as you start measuring the CLTV and bifurcating various components, you can create strategies that revolve around sales, advertising, pricing, and customer satisfaction intending to reduce costs and increase profits.

● When you are sure to gain revenue from the typical customers, you can increase or decrease the spending to ensure maximum profitability and attract the right customers to your business.

● You can make progressive decisions around production, staffing inventory, and other business costs. An unregulated measure of CLTV can lead to either overspending or underspending on unnecessary components. In this case, a business might struggle to keep up with growing demand.

Benefits of Customer Lifetime Value

As we discussed earlier, Customer Lifetime Value is a needed business tool to make effective decisions on sales, marketing, production, and many more business components. Let's look at a few advantages of using Customer Lifetime Value.

● One of the most significant advantages of using CLTV is increasing customer retention and avoiding customer dissatisfaction. It is easy to track the performance of various strategies implemented to attain the utmost customer satisfaction with accurate segmentation. This will also help you to identify the right customers and reflect upon the best strategies.

● Many retailers, restaurant chains, and tech companies have a supreme customer base that has remained loyal for a long time. With the use of CLTV, you can track the average number of visits over the customer lifetime and adopt the same data to plan methods to grow repeat business.

● High-value sales can be encouraged with the CLTV tool. Netflix is a prominent example of using CLTV to boost sales. However, using this method has made Netflix realize that a quick rise in pricing can prevent long-term customers from coming back again. Thus, businesses must ensure to keep the right balance of all the various components utilized in the business.

● A high Customer Lifetime Value indicates higher profitability. Keeping customers intact for a more extended period and encouraging them to spend more on your products and services is a benefit that helps your business reach greater heights.

How to Measure Customer Lifetime Value?

Calculating CLTV is a simple process, provided you are aware of the process of calculation. If you want to calculate CLTV manually, you should follow the below formula and steps.

● Find the value of the average sales. If you haven’t tracked before, look at the average sales for 1 or 3 months, considering it a substitution for the entire year.

● The next step is to calculate the average number of transactions per year. Do your customers visit your business frequently? Then, calculate the frequency of transactions. Calculation of frequency of transactions majorly influences the measure of CLTV.

● Now, try to find how long your average customers stay with your business. Generally, car companies or technology companies inspire lifelong customers compared to retail businesses.

● Since you have the inputs now, multiply the above three measures to calculate the Customer Lifetime Value in the form of a formula.

The lifetime value of a customer formula:

CLTV = Average Transaction Size x Number of Transactions x Retention Period

Let’s take an example of a cafe to understand Customer Lifetime Value calculation. Suppose a local cafe with four franchises has an average sale of Rs. 300 and a regular customer visits the cafe two times a week for 5 years. The CLTV of this business would be -

300 (average sales) x 100 (number of visits) x 5 years = Rs. 1,50,000

This way, you can calculate the CLTV for your business. This formula combines sales, purchase frequencies, and lifetime years that give you intricate information on all aspects determining the overall business. The formula remains the same for any type of business, whether it is a car company or software company.

Customer Lifetime Value should be adopted by businesses to understand the total earnings from the long-term customers and what should be done to inspire them to stick with your business. Small businesses can implement strategies based on CLTV to ensure maximum customer trust and loyalty. Businesses can easily forecast profitability and set budgets to acquire customers. CLTV positively encourages growth and improvement in the business.

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