Did you know that it costs up to 5x more to acquire new customers than to keep your current ones? With such high acquisition costs, you would think marketers would focus more on customer retention and less on customer acquisition, but that's not always the case.
Your customers represent so much more than a current revenue stream. They also have future value. So if you pair your customer acquisition efforts with a robust customer retention plan, you will see a nice boost in Customer Lifetime Value (CLV), and a higher CLV will lead to a more profitable business.
Customer Lifetime Value (CLV) defined.
Customer Lifetime Value — also known as Lifetime Value (LTV) — is the average amount of money your customers will spend on your business for the duration of your relationship.
Knowing your customer lifetime value is beneficial to your business because:
CLV tells you how well you’re resonating with your audience and how much your customers like your products and services.
Moreover, if you know how to calculate this metric, it can also tell you how you can improve your business operations.
Here's how you calculate it:
CLV = Average Order Value (AOV) x Purchase Frequency (PF) x Customer Lifespan.
(over a period of time)
So if we breakdown customer lifetime value and focus on how to grow one or all components of the equation (AOV, PF, Customer Lifespan) we can increase CLV.
Here’s an example:
Let’s say that you have a customer that buys a product or service from you for 5 years (customer lifespan), spends $10 with every checkout (average order value), and buys 5x a year (purchase frequency). Based on the data, this customer’s lifetime value = $250, minus the money you spent to acquire said customer.
$10 (AOV) x 5 (PF) x 5 (lifespan) = $250
Now, let's say that you spent $1,000 on paid advertising to get this customer as well as 49 others (50 total, $20 per customer). Since your calculated CLV totals $250, you spent $1,000 to acquire 50 new clients who spent $11,500 on your products and services.
- Cost of paid advertising = $1,000
- Customers acquired = 50
- Cost per customer acquisition = $20
- Customer Lifetime Value = $250
- Average Order Value = $10
- Purchase Frequency = 5
- Lifespan = 5 years
While this example is basic, it highlights why these data sets are so important.
Now that we've established customer lifetime value and what it tells you, we can jump into how we leverage all of this information to become more profitable.
Why Customer Lifetime Value is essential.
According to Forbes "a 5% increase in customer retention can increase a company’s profitability by 25% to 95%." So if we focus on strengthening customer relationships, we will see a definite upswing in profits. Moreover, strengthening customer relationships will also have a positive affect on Customer loyalty and CLV.
Here's another example:
We have another $1,000 dollars to spend on customer acquisition and, from experience (from our previous example), we know we can attract 50 new clients that will each generate $230 of profit. But what if we focused on an upsell campaign instead of acquiring those 50 new customers? How would that affect our CLV equation?
Let’s find out.
Upon closer analysis, we see that those 50 new customers all purchased the same product, hair gel.
Now that we identified the product data, we can use the advertising dollars to come up with a complimentary item to go with the gel, like a set of $4 hair ties.
You create a segment for your 50 customers, create a killer upsell ad (that’s served a few days before their usual check-out), and end up increasing AOV by $4.
By opting to do an upsell campaign instead of acquiring 50 additional clients, you have increased your AOV 40%, so now your new CLV is $350.
$14 (AOV) x 5 (PF) x 5 (lifespan) = $350
New Customer CLV = $250
Customer Retainment CLV = $350
In choosing to focus on your current customer base instead of acquiring new customers, you boosted your profits, your average order value, and your customer lifetime value.
This hypothetical situation lays out the importance of knowing your CLV. Because we understand how utilizing CLV calculations can increase profitability without requiring new customer acquisition, you can allocate your resources more effectively and efficiently. So while you still want new customers, it’s crucial not to take your old ones for granted.
Being well acquainted with your customer lifetime value is super important. If you don’t focus on ways to improve it, you could be missing out on more substantial future profits.
If you want additional information regarding how to maximize your CLV, you’re in luck because DataQ can help. With DataQ, you’ll never have to do manual calculations again, it'll give you the freedom to focus on what matters most to your business, your customers. And on that note, here’s what we suggest:
- Focus on customer retention
- De-aggregate your CLV by thinking in smaller terms (i.e., the upsell campaign to increase AOV).
- Study your customers and infuse your campaigns with your learnings