How to Calculate your Customer Lifetime Value

The digital world is constantly spinning, and new tech is popping up faster than you can say "customer retention." Companies have all sorts of fancy new gadgets and gizmos to try and keep their customers grinning.

But let's be real: getting a customer to trust you is like training a cat, seriously tough. Keeping them happy and loyal? That's the real Everest. The competition is savage, and everyone from the huge corporations to the tiny startups is feeling the heat. And the million-dollar question that keeps CEOs up at night? How the heck do you put a dollar sign on a happy customer?

If you're pulling your hair out over that, take a deep breath, buddy. You've hit the jackpot. This article is your guide to finally nailing down your Customer Lifetime Value (CLV).

Time to dive in!

What is Customer Lifetime Value (CLV)?

Let's be real: Keeping the customers you already have is way better for your bank account than trying to woo and keep a bunch of new folks. It's like finding a comfy pair of shoes, once they trust you, they'll keep coming back to what they know (that's you!).

But here's the head-scratcher: figuring out which customers are your real MVPs. That's where Customer Lifetime Value (CLV) swoops in to separate the casual browsers from the big spenders in your (hopefully huge) customer fan club.

Think of it this way: a customer's worth is measured by how much sweet, sweet profit they'll toss your way. So, CLV is basically the grand total of cash that customer will drop over their entire relationship with your company.

How to calculate your CLV?

You can calculate Customer Lifetime Value (CLV) with this basic formula:

Customer Lifetime Value = Customer Value × Average Customer Lifespan

This formula requires two metrics:

Customer Value is calculated by multiplying the average purchase value by the average purchase frequency rate (we'll cover this shortly).

Example: If a customer spends an average of $50 per visit and visits 4 times a year, their Customer Value is $50 * 4 = $200 per year.

Average customer lifespan is calculated by averaging the time between the first time a customer bought something and the most recent time they bought something.

Example: If your average customer shops with you for 3 years, the Average Customer Lifespan is 3 years. Using the previous example, the CLV would be $200 (Customer Value) * 3 (Average Customer Lifespan) = $600.

Or, you can use a more complicated formula that will give you a more accurate result. This formula is:

Customer Lifetime Value = (Average Purchase Frequency × Average Purchase Value × Average Gross Margin × Average Customer Lifespan in Months) / Number of Clients for the Period

Below are a few metrics that are needed for this CLV formula:

Average purchase value

The average purchase value is calculated by dividing your company’s total revenue within a single period (let’s say in one year) by the number of purchases customers make throughout the year.

Example: If your total annual revenue is $500,000 and you had 10,000 separate purchases in that year, the Average Purchase Value is $500,000 / 10,000 = $50.

Average purchase frequency

Average purchase frequency is calculated by dividing the number of purchases in the period by the number of unique customers who made purchases during that period.

Example: If you had 10,000 purchases in a year and 2,500 unique customers made those purchases, the Average Purchase Frequency is 10,000 / 2,500 = 4 purchases per customer per year.

Average gross margin

Average gross margin is calculated by subtracting the cost of an average sale from the revenue gained from an average sale. This is usually expressed as a percentage of revenue.

Example: If the average revenue from a sale is $50 and the cost of the goods/service for that sale is $20, the gross margin is $30, or 60% ($30/$50). For the formula, you would use the margin percentage as a decimal (e.g., 0.60).

Simple CLV Example: Calculating a Customer's Value

Let's use the simplest formula for a quick-and-dirty estimation.

Simple Formula Reminder:

Customer Lifetime Value = Customer Value × Average Customer Lifespan

The Scenario:

Imagine a single customer's purchasing history:

• Transaction 1: Month 1, $75
• Transaction 2: Month 2, $50
• Transaction 3: Month 4, $125
• Transaction 4: Month 5, $100
• Total Timeframe: 5 months

Calculation Steps:

1. Calculate Total Revenue (for the observed period): $75 + $50 + $125 + $100 = $350$
2. Calculate Average Purchase Value (APV): APV = Total Revenue / Number of Transactions = $350 / 4 = $87.50
3. Calculate Purchase Frequency Rate (PFR): PFR = Number of Transactions / Timeframe (in months) = 4 / 5 = 0.8 purchases per month
4. Calculate Customer Value (CV) per Year: Since the simple CLV formula uses "Customer Value" (usually annualized), we need to estimate this customer's value over a full year. CV (Annualized) = APV × PFR (Monthly) × 12 months CV (Annualized) = $87.50 × 0.8 × 12 = $840
5. Estimate CLV (Based on an assumed Average Customer Lifespan): For this final step, we must assume the company's Average Customer Lifespan (ACL). Let's assume the company's historical data shows an ACL of 3 years.

CLV = CV (Annualized) × ACL CLV = $840 × 3 years = $2,520

Based on their activity over five months, this customer's estimated Customer Lifetime Value (CLV) is $2,520. This means the company can expect this customer to generate $2,520 in revenue over the total 3-year relationship.

Why is CLV important?

Now that you know how to calculate Customer Lifetime Value (CLV), let's explore why it's a vital metric for your business:

The Importance of Customer Lifetime Value (CLV)

1. Drives Higher Revenue: Focusing on customers with a high CLV potential is a strategic way to boost revenue. By identifying and marketing to customers who are likely to make repeat, larger purchases, you can predict which customer segments will be most profitable for your company.
2. Enhances Customer Retention: Understanding a customer's behavior is the first step toward long-term retention. Identifying your high-CLV customers provides valuable insights into what drives their loyalty, allowing you to develop innovative strategies to keep all your customers coming back.
3. Uncovers Key Customer Behavior: Success in business often comes down to making accurate predictions and taking calculated risks. CLV analysis helps you pinpoint your target customers' consumption patterns. Knowing when they purchase—for instance, only in December or right after payday—is crucial for designing effective, timely promotions and a solid marketing strategy.
4. Identifies Changes in Purchasing Habits: CLV serves as an early warning system. By monitoring fluctuations in customer CLVs, you can quickly spot emerging trends or identify potential problems in consumer behavior, allowing you to react and capitalize on opportunities or mitigate risks swiftly.

CLV in Soran Dashboard

Focusing on your most profitable customers is essential, and calculating your Customer Lifetime Value (CLV) is an excellent, objective way to assess which customers provide the most value.

This article has introduced three CLV formulas, the simplest of which is:

Customer Lifetime Value = Customer Value x Average Customer Lifespan.

CLV offers great insight into your customers, as does Soran. With Soran, you can gain deeper understanding of your business's finances, reporting, and Return on Investment (ROI). Soran also provides the Soran Pixel feature, which helps you learn about customer behavior.

Don't wait! Get started with Soran today!