Tweet

Calculating Customer Lifetime Value

Written by: John Brennan

Article Overview: Do you know what an average customer is truly worth to your company? By calculating your Customer Lifetime Value (CLV), you'll be able to answer that question. CLV is the amount of profit a customer delivers to your company for as long as the customer is buying from you. It's typically calculated as the net present value (the value in today's dollars) of the profit you'll earn from all of a customer's purchases over time.

Calculating Customer Lifetime Value

When you know your CLV, you have an extremely powerful tool that helps with:
• Acquisition: You'll have a better understanding of what you can spend to acquire customers.
• Targeting: You'll know which customer segment delivers the most profit to your company and you can focus more marketing efforts toward that segment.
• Return on investment: By using CLV in your ROI calculations for marketing campaigns, you'll have a much more accurate measure of campaign performance.
• Customer retention: You can determine how much you can spend to profitably retain customers.
• Single-customer profitability: You can calculate the profitability of an individual customer.

CLV becomes more important as your marketing budget rises and your customer base grows. Yet even an early-stage company can benefit with a simple CLV estimate.
Before you begin you'll want to look at CLV for different groups of customers, so make sure you've defined those segments. CLV is a valuable tool to improve your marketing campaigns and budget; it's also used when you're working on customer retention and ROI.
There are several figures you'll need for your CLV calculations:
• Cost of goods sold (COGS): the cost to physically produce a product or service
• Gross profit: the difference between the price of your product and the COGS

The CLV calculation is most valuable when you measure it by customer segment - similar groups of customers who use your products/services in a similar way. For each segment, determine how long an average customer stays with you -- the "lifetime". Look at your customers' buying patterns and calculate the total number of purchases they make and the time between those purchases.


To calculate the CLV for each customer segment, estimate how many purchases you think an average customer will make before the relationship ends (the customer no longer buys from you). Then estimate the average length of time between purchases (in days), the average revenue per purchase and the gross profit margin for the revenue generated by these customers (as a % of revenue).


The Net Present Value (NPV) is the value of a future stream of cash flows in today's dollars. In general, it's better to have a given amount of money today than tomorrow. If you have it today, you can invest it and earn a return. If you don't have it until tomorrow, you miss the chance to invest, and inflation may also eat away at its value.

EXAMPLE: If you were offered $5000 a year from today, how much would you take if you could have it today instead? Would you take $4500 if you could have it today instead? $4,800? $4,000? The amount you're willing to take today is the Net Present Value (NPV) of the $5,000.

It's important to calculate NPV to prevent overspending on marketing and/or operations. If you think a customer will spend $10,000 a year with you for three years, that customer isn't worth $30,000 because that $10,000 in years two and three is actually worth less than $10,000 today. Calculating NPV will give you a more accurate value for the customer.

Related Articles
  Lifetime Value of a Customer is Unlimited
  Why customer lifetime value is the most important measurement in your business
  How A Simple Question Earned Thousands Of Dollars
  Calculating the Value of Customized Training
  Smart Women Prefer the “Limited” Lifetime Warranty

Article Tags: customer lifetime value, present value



Related Forum Posts
Re: I really feel great today because . . . . . - I really feel great today because... I wrote a press release to market my stock market coaching business for women. Well, within hours, I received a phone call from a representative at Lifetime Television. They invited me to be on The Balancing Act, a morning tv show, which airs nationally to 2 million people in my target market...women!! As most people know, Lifetime is known as the Womens Network. I am sooo excited! I will be taping the interview in November, and it will air in January 2011. Press releases are a great method for marketing your business, especially when you can highlight what makes your business unique. Aneshia
Re: Two Useful Books To Help You Focus On The CLIENT - Hi David, To add to your thread, I'd like to recommend Jonathan Tisch's "Chocolates On The Pillow Aren't Enough: Reinventing The Customer Experience". Tisch's book includes content on "Welcoming Customers", "The New Art of Customization", "The Challenges of Customer Diversity" and "Offering Something Extra to Your Customers" to name a few.
Re: Paypal process $315 million in payments per day. - I agree with you David, their Customer relations suck. This mean other payment systems like 2CO and WORLDPAY should work on their customers relations to take more slice of the market.
Re: Welcome to Entrepreneur University! - Hi Evan and GT, Can you clarify? If you join the "Preferred Customer" you are not entitled to commission? Why? This is the the $79.95/month account, I don't understand why you are not getting commission from it?
Re: Email Marketing Benefits - Robert, Many lists consist of more prospects than customers. Customer lists are the best, but they are created because prospects successfully transform into customers.


Share this article with your friends. Fund someone's dream.

Leave a comment below or share on the left and you'll help support entrepreneurs in Africa through our partnership with Kiva. Over $50,000 raised and counting - Please keep sharing! Learn more.

Tweet

Newsletter

Get advice & tips from famous business
owners, new articles by entrepreneur
experts, my latest website updates, &
special sneak peaks at what's to come!

Name:
Email:

Popular Articles

Setting Goals for your Home Based Business

How to Sell to the Price Driven Customer

12 Principles to Spark Innovation

Suggestions

Email us your ideas on how to make our
website more valuable! Thank you Sharon
from Toronto Salsa Lessons / Classes for
your suggestions to make the newsletter
look like the website and profile younger
entrepreneurs like Jennifer Lopez.