Customer lifetime value (CLTV) is exactly what the name implies – how much a customer is worth to a business, over their entire lifetime with that business.
Now, don’t get it confused: CLTV is not a measure of what each customer spends on transactions. Rather, it predicts what the average customer approximately spends until they are no longer interested in buying from a business.
This is where things get complicated.
Differences in customer preferences, product offerings, purchase frequencies, and order volumes can make CLTV difficult to calculate. However, with the right knowledge and tools, you can find your customer lifetime value in no time.
Read along to learn about:
- What is Customer Lifetime Value (CLTV)?
- Why is CLTV an Important SaaS Metric?
- Customer Lifetime Value Models
- How to Calculate CLTV
- 3 Customer Lifetime Value Examples
- How to Increase CLTV? 7 Tips
What is Customer Lifetime Value (CLTV)?
Customer lifetime value (LTV, CLV, or CLTV) is a metric that measures the total amount of money a company expects to earn from the average customer throughout the entire business relationship. In simpler terms, it’s the money you make from a customer up until they stop doing business with you.
For example, if a customer subscribes to your product for one year, the amount they will pay during that period will determine their lifetime value.
Why is CLTV an Important SaaS Metric?
Why do SaaS businesses care about CLTV?
Here are some key reasons to track, use, and improve CLTV:
#1: Control Customer Acquisition Costs
CLTV goes hand in hand with another important metric known as Customer Acquisition Cost (CAC).
CAC is the total sales and marketing expenses a business makes to convert a lead into a customer. So, basically, CAC includes any investments you make in attracting customers, such as special offers, discounts, and other marketing efforts.
Now, CLTV should always account for CAC, or you will end up spending more than you earn. Specifically, if you’re a growing SaaS company, you should aim for a 3:1 ratio or higher. For example, if your company’s CLTV is $3,000, the total CAC per customer should not be higher than $1,000.
#2: Understand Customer Behavior Better
No business wants to spend money and resources on acquiring customers that won’t be profitable. On the contrary – they all want to direct their sales and marketing efforts toward the best, most loyal leads.
The customer lifetime value metric helps identify who these high-value customers are.
By regularly keeping track of your CLTV, you can segment your customer data into different categories based on their specific lifetime values. The higher the CLTV, the higher their value. Armed with this knowledge, you can then answer key relevant questions about your users and clients, such as:
- Which customer categories have the highest LTV?
- Which offers are best-suited for my customers?
- How much should I spend to acquire a lead?
- How many resources should I invest in retaining or winning back customers?
- How much time should my sales and marketing team spend on customer acquisition?
#3: Boost Customer Loyalty
Consistently optimizing your CLTV and producing value through customer support, loyalty programs, discounts, and special offers increases both customer loyalty and retention.
Additionally, more loyal customers and trust towards your brand can effectively lower the churn rate and increase referrals, positive reviews, and sales.
Customer Lifetime Value Models
If you’ve been subscribing to Spotify for the last 3 years, for $30 a year, then your CLTV has been $90 – pretty straightforward, right? But Spotify has over 180 million users and 4 different subscription plans, which makes CLTV way more complicated to calculate.
And this doesn’t just apply to Spotify. Customer lifetime value is generally a complicated metric to calculate as SaaS businesses have complex products and business models.
This said we can divide the types of CLTV calculations into two main categories: historical and predictive.
Here is what each is all about:
#1: Historical Customer Lifetime Value
The historical CLV model uses past, historical data to find the value of a customer without considering if they will continue to do business with the company or not. So, this model puts all of your customers, old or new, into one basket.
This is the simplest and oldest method of calculating CLTV. It assumes that there is an average, constant spend, and churn rate for all of the customers. Hence, the approach is useful if most of your customers share the same preferences and interact the same way with your brand, over a specific period of time. Think of a customer purchasing a Christmas tree each year, from the same retailer.
If that’s not the case, however, this model can be tricky, as differences between clients can easily distort the results and give you an inaccurate CLTV.
Want to learn more about using historical data to predict upcoming revenue? Then, head on over to our guide on calculating revenue run rate.
#2: Predictive Customer Lifetime Value
The predictive CLTV model is more complex but way more accurate than the historical model. It’s done through artificial intelligence and analytical tools which take customers’ historical data and their tendency to churn to make smart CLTV calculations.
The predictive model can help you better identify your most important consumers, the products and services that generate the most income, and the methods you can use to increase customer retention.
How to Calculate CLTV
The CLV formula can take many different forms.
This said, the simplest equation for CLV goes as follows:
|Customer Lifetime Value = Customer Value x Average Customer Lifespan|
Let’s break down the formula, step-by-step.
Step #1: Average Order Value (AOV)
Find AOV by dividing your company’s total revenue by the number of purchases, for the selected period (usually a year).
AOV = Total Revenue / Number of Orders
Step #2: Average Purchase Frequency Rate (APFR)
Find APFR by dividing your company’s total number of purchases by the number of customers who made these purchases.
APFR = Number of Purchases / Number of Customers
Step #3: Customer Value (CV)
Calculate customer value by multiplying the average order value (AOV) with the average purchase frequency rate (APFR).
CV= AOV x APFR
Step #4: Average Customer Lifespan (ACL)
Find ACL by dividing the total sum of customer lifespans by the total number of customers.
ACL = Sum of Customer Lifespans / Number of Customers
Step #5: Find CLTV
Finally, take the previously calculated customer value and multiply it by the average customer lifetime (ACL).
The result should give you an approximate revenue you should expect from the average customer throughout their entire relationship with your company.
CLTV = CV x ACL
3 Customer Lifetime Value Examples
The best way to understand how CLTV works is through examples.
Here are 3 examples from different industries to better understand how to calculate CLTV for your company:
#1: SaaS Subscription
Assume an online music streaming service has multiple pricing plans, but the average customer spends $14 per month. Customers usually subscribe for 5 years and use automatically recurring monthly payments.
|CLTV = $14 (average order value) x 168 (purchase frequency) x 5 years (customer lifetime) = $11,760|
Do you have a subscription-based company and want to learn more about calculating repeated revenue? Then, check out our complete guide on annual recurring revenue (ARR).
#2: Juice Shop
Let’s say a Green & Proteins Juice Shop has an average sale of $6. The typical customer is a local worker who visits three times per week, 45 weeks a year, over an average of 2 years.
|CLTV = $6 (average order value) x 135 (purchase frequency) x 2 years (customer lifetime) = $1,620|
#3: Phone Manufacturing
A phone manufacturing company has a much higher average sale amount, with a lower purchase volume. In this example, we’ll assume that the average customer buys a new phone once a year for $900. Customers are loyal to this brand and tend to keep buying from them for up to 10 years.
|CLTV = $900 (average order value) x 1 (purchase frequency) x 10 years (customer lifetime) = $9000|
How to Increase CLTV? 7 Tips
Here are our top 7 tips on how to increase your customer lifetime value:
#1. Apply Omni-Channel Marketing
In order to maintain a high CLTV, you have to invest time and effort into building an effective customer support program. The best way to do this is by implementing Omni-channel marketing, which is the selling and serving of customers on all platforms, channels, and devices.
Instead of only offering support on your official company website, for example, you could engage with customers through Facebook Messenger, live chat, Instagram, and phone. This way, no matter where customers are, your team and services are only a click away.
#2: Regularly Check-In with Customers
Whether or not your customers are regularly asking for support, they could be unhappy with your service or looking at your competitors for an alternative. So, in order to increase their lifetime value, get ahead of problems, and keep them from churning, it’s important to regularly check in with them.
Consider sending follow-up messages to express gratitude, asking for feedback through email surveys and forms, providing special add-ons and upgrades, or inviting them to network events.
#3: Create a Knowledge Base
If you don’t already have one, create an external knowledge base on your company website where customers can go learn anything they need to know about your products, services, and industry.
How does a knowledge base helps increase CLTV?
The information, tutorials, and video guides in your knowledge base can keep customers happy by offering them a quick solution or answer, without the need for human interaction.
In turn, this also removes some weight from your employees so they can focus on customer issues that require a more hands-on approach.
#4: Upselling & Cross-Selling
Upselling and cross-selling are two sales techniques businesses use to increase the average sales value of a customer.
Upselling aims to convince customers to buy a more expensive or upgraded version of a product. So, for example, let’s assume a customer has added a pair of shoes from last year’s collection to their shopping cart. Exposing them to images of similar, but more expensive, shoes from the new collection could lead to an upsell.
Cross-selling, on the other hand, focuses on making recommendations for complementary products. For shoes, these could be socks, insoles, or shoelaces, which increase the value of the purchase and the customer’s overall LTV.
#5: Set Up a Referral Program
A referral program encourages your existing customers to share their experience with your brand with friends, colleagues, and family. In exchange for the referral, you can offer your customers a reward such as a discount, coupon, or gift card.
The approach is a great way to bring in new, high-quality customers at a very low cost, as research reveals that 92% of people trust recommendations from friends and family on top of all other forms of advertising.
#6: Stay Relevant on Social Media
Almost every brand is on social media, in some way, shape, or form. However, not many companies have a thriving social media presence that is continuously gaining them new customers and engagement.
The key to staying relevant on social media in the modern age is honesty and humanity. People want to get to know companies on a personal level, regularly engage with them, and follow relatable voices.
Do this by sharing office photos or snapshots of your team, posting timely and relevant memes to your brand’s social media platforms, using current lingo, and continuously replying to people when they mention you or share your content.
#7: Start a Loyalty Program
Loyalty programs are incentives companies use to reward current customers. Each program works differently – some companies use a point-based system while others reward customers according to how much money they spend. These incentives help customers feel as though they are saving money, which makes them more inclined to continue supporting the brand.
We hope this guide has helped you better understand the importance of keeping track of and improving your Customer Lifetime Value.
Here are some of the main points we’ve covered:
- Customer Lifetime Value, abbreviated as CLTV, CLV, or LTV measures how much money the average customer generates over their entire relationship with the company.
- Keeping track of CLTV and making efforts to improve it helps you control customer acquisition costs, gives insights into customer behavior, and boosts brand loyalty.
- The simplest way to find CLTV involves multiplying Customer Value with the Average Customer Lifespan.
- You can increase your LTV through Omni-channel marketing, referral & loyalty programs, upselling & cross-selling strategies, and continuous nurturing of customers through social media platforms.