Everything has a value, whether material or intangible. A stylish car, a loved one or a childhood memory. Each object, living being, or moment is assigned a specific value. Human actions, thinking and feeling are similarly derived from individual values. However, how heavily intangible and material values are weighted depends on the person concerned. One strives for material values in the form of high-quality possessions, while another focuses on different things. Customers and consumers of products and services also have a certain value for companies. This so-called Customer Lifetime Value is essential to assign a customer to a particular category. Measuring the exact value of a customer and therefore (possibly) even being able to separate the wheat from the chaff sounds more than tempting. In this way, it is finally possible to define and highlight particularly profitable customers. If it is possible to determine the particularly lucrative consumers, they can be addressed even more specifically through individual marketing. At the end of the day, every company wants to know how to increase profits and save money, right?
This marketing term describes customer value over the lifetime of the business-customer relationship. Customer Lifetime Value is essential for many companies for future budget planning. It’s a key metric describing the actual value of a customer for the company and is a sum of all the financial transactions that the customer has made so far - and also projects future revenues. The resulting value helps to make long-term business success predictable and also estimates how much one needs to invest in order to bind the customer to the company.
This is an important metric in the area of business administration, with which marketing activities can be better planned and, if necessary, expanded in order to increase Customer Lifetime Value even further.
All roads lead to Rome - and there are also many ways to calculate lifetime customer value. If you want to estimate future customer relationships and their value, you cannot lump all your customers together. The reason for this is that not all consumers have the same importance for the company. Therefore, it is important to determine their individual value. Several influencing factors should be taken into account when calculating:
Different methods for calculating customer value differ greatly in content, orientation, and complexity. To understand the differing formulas, it helps to illustrate them: Let's say a company invests an average of five euros in advertising and marketing to attract a customer (cost of customer acquisition). This customer buys an average of seven products a year for ten years. On average, each of these products is worth ten euros, which is why this customer generates revenues of around 70 euros per year or 700 euros over the course of the decade. In order to calculate the Customer Lifetime Value, the costs of customer support are deducted. In our case, we assumed five euros, which gives a customer value of 695 euros.
This simple example contains all the important metrics needed for a calculation:
But there are other more complex approaches. For example, the following formula tends to focus on the temporal variables:
Customer Lifetime Value = Coverage amount (m) x Repurchase rate (r) / (1 + discount factor (i) - Repurchase rate (r))
Of course, this data also has to be defined for the calculation. The individual key figures can be broken down step by step:
Coverage amount (m): The average purchase value is determined by dividing a customer's total turnover generated for the company over a period of time by the number of purchases made in the same.
Repurchase rate (r): Describes the proportion of customers who make purchases within the specified time period. For example, this rate could be 30 percent.
Discount factor (i): The cost discount factor describes the discount factor of future payments to determine the cash and present value.
However, a formula that looks at the profit margin on realized sales during the average customer lifetime has the disadvantage that the costs of customer acquisition are not taken into account.
Customer Lifetime Value = Customer Lifetime (t) x (Customer Sales (s) x Purchase Interval (c) x Profit Margin in % (p))
Here, too, the key figures used can be assigned to a definition on the basis of which the respective value for the company can be determined.
Customer lifetime (t): Defines the average active lifetime of the customer relationship.
Customer sales (s): Describes a customer's average revenue per purchase.
Purchase interval (c): This is the number of purchases made within a given time window. For example, a customer could make three purchases a year.
Profit margin (p): Company-related profit margin as a percentage per customer.
Unfortunately, the Customer Lifetime Value (CLV) has often been underestimated companies. Although according to Kissmetrics, new customer acquisition is seven times more expensive, many entrepreneurs focus exclusively on it. Although it seems at first glance that new customers are increasing sales and helping the company to grow, it is often overlooked that new customer acquisition must also remain profitable. If you spend more than the customer spends afterward, these expenses are a net loss. If you want to be in the black in 2019, you have to realize that pure new customer acquisition is not the most profitable approach. Which customers are ultimately worth more to a company: Those who have made one big purchase and then become dead weights or those who have been among the most loyal and reliable customers for years? The answer is obvious and more and more companies are recognizing this potential: the most valuable customers for the company are regular customers.
The longer and more often a customer buys from a company, the higher their Customer Lifetime Value. The calculation of Customer Lifetime Value helps companies plan their budgets and use resources effectively. If the customer value is high, it is worth putting money into Customer Loyalty. Many marketing experts optimize the customer journey and consolidate their existing customer care in order to attract loyal and cash-rich customers and to retain them as long as possible. However, the calculation of the Customer Lifetime Value is not only of interest to the marketing department. Other departments within the company can also draw conclusions from customer value analysis.
For example, the CLV is used in product development to determine how the customer's expectations and needs can be met. The data is essential for the customer experience, especially in budget planning. Sales focus more on which customer segment is expected to have a high Customer Lifetime Value and finds out which customers are most lucrative for the company.
The CLV has advantages that can be clearly defined. In this way, it offers companies the opportunity to adapt their own marketing and sales strategies in such a way that their yield can be increased over the long term. However, the customer value is based on estimates and is therefore associated with a measure of uncertainty. In particular, the planning of future transactions is problematic as these can only be predicted very roughly. Forecasts for new customers are particularly difficult, as in the worst case, sales may be lower than expected. However, the larger a customer’s purchase history with the company, the easier it is to make more accurate guesses.
In e-commerce, too, companies focus primarily on one thing: the customer. Customer centering and the design of a unique customer journey are in the foreground. Here, too, the analysis of the Customer Lifetime Value can provide an excellent basis for budget planning and the evaluation of costs per customer. The marketing and the associated communication measures can thus be constantly reviewed and adapted.
The question now arises as to how it is now possible to increase the CLV of customers and to increase sales. Here, too, there are a variety of options, such as improving Customer Loyalty and customer satisfaction. The latter sounds quite logical: satisfied customers usually spend more money and buy more often. In order to increase customer satisfaction, it is important that companies focus on consumers and expand their Customer Orientation. The Customer Journey and Customer Experience should be designed in the best possible way to make a good impression. Increasing Customer Loyalty is an essential factor in improving CLV. Effective Churn Management is also essential. With these steps, it is possible to increase the value of the customer relationship.
If you want to increase the CLV, you have to strengthen Customer Loyalty and increase the satisfaction of the consumer. If you want to know exactly whether the customer is satisfied and where you can still make improvements as a company, you should take advantage of the Net Promoter Score. The NPS asks the customer a direct question: "Would you recommend the product or service to friends or acquaintances?" There is the possibility to express further criticism in a comment field. Thanks to the NPS and an analysis of the data obtained, important insights on customer satisfaction are gained. In this way, companies are able to identify the points that the customer finds disturbing. An improvement of this can then be made. Thanks to the optimization of the individual measures, the customer's lifetime is extended and the customer is more likely to buy again - this also increases the Customer Lifetime Value.
Let's summarize all the information: every customer has a certain value for the company. This customer value is called Customer Lifetime Value and offers various interpretations, applications, and calculation options. The following key figures are important for the calculation of Customer Lifetime Value:
The calculation of Customer Lifetime Value offers companies the opportunity to optimize their own marketing and strategies in customer management and sales. In this way, individual measures can be tailored directly to the customer. A customer is lucrative for a company if the purchase value is higher than the amount the company has invested to attract him as a customer. So the more effort invested in a customer's value creation, the more revenue the company should generate. Thanks to the customer value analysis, it is possible to identify the individual value of a customer and thus to exploit the respective potential. Companies that act smartly in the course of Customer Lifetime Value and do not underestimate this metric can reap long-term benefits.
Content Marketing Manager