Miscellaneous

Published on December 21st, 2016 | by Guest

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Easy Ways On How To Calculate a Customer’s Lifetime Value

The benefits of calculating a Customer’s Lifetime Value (CLV) are not just limited to e-commerce sites. CLV is the projected total net profit a business makes from any given customer. You may be spending a lot on acquiring a certain target market while neglecting loyal customers that sustain your revenues.

CLV is applicable in all types of business, whether online or offline. Its most important benefit involves profitability. According to Harvard Business School, maintaining a long-term relationship with the right customers can have a strong impact on profitability. “The companies that fail to recognize this truth overspend in marketing to acquire and retain less profitability or even unprofitable customers and do not spend enough on keeping profitable ones,” it notes.

Boost your profitability with CLV

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Understanding the CLV can enable you to change your patrons’ lifetime value. Distinguish the large but infrequent spenders from the small yet regular buyers. You can devise a rewards program to encourage the former to spend more frequently and the latter to spend on larger purchases. Without knowing the CLV of each patron, you couldn’t improve your customer retention rate.

CLV is used by large companies operating in more than one territory or region. By presenting an overview of customers’ buying patterns, CLV can help detect the cross-selling practices of sales personnel. This concept also guides small businesses in choosing customer service channels. A 24/7 customer support may not be feasible if the customers with the highest CLV only transact during business hours.

CLV and digital marketing

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Another benefit of CLV relate to digital marketing. Digital marketing, which aims to “promote brands through various forms of digital media, enables a business to map out an action plan to reach out to its target audience. For instance, a digital marketing agency in the Philippines can use CLV as a guide in creating the right content in a certain format delivered via an effective platform. If, according to your CLV analysis, your Instagram-loving millennial customers have the highest CLV, you’d know the content marketing tactics to implement.

Computing your CLV

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You can use several formulas for CLV.  Here’s a list of tips on how to calculate CLV.

First method

A simple approach to get the CLV is through this formula:

(Average Order Value) x (Number of Repeat Sales) x (Average Retention Time).

Let’s say that Coffeeshop ABC records that its customers within the age bracket of 20 to 30 are spending an average of $20 per month while customers aged 31 and above spend an average of $10.

Using the above formula, we shall come up with the following CLV for each market:

Customers aged 20 – 30: ($20) x (12 months) x (2 years) = $480 CLV

Customers aged 31 and above: ($10) x (12 months) x (2 years) = $240 CLV

Thus, each millennial customer has a CLV of $240 per year, or $480 in two years, which is double the CLV of the older customers.

Second method

For a more accurate way of getting your CLV, factor in another concept: the Cost to Acquire Customers (CAC). To get your CAC, divide all your marketing expenses and other costs to acquire customers by the number of customers acquired in that period. Example, Coffeeshop ABC spends $1,000 on marketing and promos in a 12-month period, earning it 100 customers. Its CAC is $10.

Incorporate CAC into your CLV analysis through this formula:

(Annual Profit Contribution per Customer) x (Average Retention Time) – (CAC).

In Coffeeshop ABC, each millennial customer contributes $240 annual profit and stays as a customer for an average of two years. The annual CAC is $10. Using the above formula, the CLV of each millennial patron is $460 for a period of two years.

Third method

Here’s an even more detailed formula. First, get the average of your variables. Compute the average customer expenditure per visit, the average number of visits per week (or the “purchase cycle”), and the average customer value per week. The customer value can be computed by multiplying the average expenditures by the number of visits per week.

After averaging your variables, calculate the lifetime value. Take note of the following constants: t = the average time someone remains a customer; r = Customer Retention Rate or the percentage of customers who repurchase over a period of time; p = Profit Margin per Customer; i = Rate of Discount, or the interest rate to know the present value of future cash flows; and m = Average Gross Margin per Customer Lifespan.

You can use any of the following equations in getting your CLV:

  1. Simple equation: 52 (a) x t
  2. Custom equation: t (52 x s x c x p)
  3. Traditional equation: m (r / 1 + i – r)

“Companies will typically use these equations (separate or in combination) to help determine their marketing budgets, and ultimately, the cost of acquisition,” according to KISSmetrics.

Important factors to consider in computing CLV

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There is a wide menu of free apps you can use to compute your CLV. There are simple, straightforward programs and more complex apps that consider essential accounting principles. Harvard Business School’s CLV calculator takes into consideration the following factors related to a customer:

The average amount he spends per purchase, the gross margin associated with each purchase, his average number of transactions per year, the average acquisition cost for each new customer, the average customer retention rate, and the discount rate. The rate of discount is usually between 8% and 15%.

The CLV calculator generates the average revenue per customer as well as the profit per customer in a year. Unlike the simpler CLV calculators you can find online, the Harvard tool allows you to modify assumptions based on changes in internal and external factors. “The CLTV tool enables you to identify valuations for customers with different characteristics. Moreover, you may ultimately be able to influence the behavior of certain customers and consequently change their LTV,” the business school notes in its website.

Setting up an e-commerce site is not as easy as publishing pages online. You need to consider methods that can turn it into a powerful tool toward profitability. Knowing how to compute CLV is one such technique.

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