Understanding customers, what they value and how much they are worth is essential for any organisation hoping to drive growth. Knowing where customers come from, what they care about and how much they spend with a brand at different touchpoints will help develop marketing strategies to drive future expansion.
This article will explore the concept of Customer Lifetime Value (Sometimes called CLV, CLTV or LTV) and some of the key metrics that will give businesses visibility into how much each customer is worth, in order to build tailored strategies moving forward.
Why is Understanding LTV Important?
In today’s highly competitive marketplace, success is less about gaining new customers and more about retaining existing ones and maximising the amount of revenue they bring. (Due to the current economic situation, focusing on customer retention is more important than ever.)
Measuring customer loyalty and retention brings insights into which customers are likely to respond positively to certain incentives or marketing campaigns. For example, observing a difference in the average LTV between younger and older age segments, an organisation may decide to employ a new strategy focused solely on the younger age group, building relevant branding towards this demographic.
LTV is often used as a measurement of customer loyalty as it provides insight into how likely a customer is going to remain with a business over time. It also helps in understanding the value of a customer base as a whole, providing insights into how much a business is worth. This data is essential when it comes to making decisions around whether to adjust a business model or make changes to marketing strategies.
How to Calculate Customer Lifetime Value
The customer lifetime value formula is as follows:
Annual profit contribution of a customer x the number of years they remain a customer – customer acquisition cost (CAC) – any costs associated with providing the product and servicing the customer and any retention costs.
The CAC Break-Even Point
As well as understanding the value of each customer, it is also useful to determine how long it takes to break even on the cost of acquisition. Suppose that $4,000 was spent on advertising; if each customer spends $100 with a brand, it will take 40 customers to break even on the costs associated with acquiring new customers. This is an important metric for budget management.
Customer Retention Rate
This metric involves calculating the percentage of customers who are still making purchases after a set period of time. A high retention rate is a sign that customers are satisfied with the products and services, and it may indicate that they are likely to make larger purchases in the future.
Suppose a company onboards 20 customers. If the average customer retention rate is 85%, then 17 of those customers will stay with this company for longer than six months. This data is important in terms of determining methods of improving the retention rate.
Customer Referral Rate
This refers to the percentage of customers who are actively promoting a business to others. A high referral rate can significantly boost a company’s bottom line. To calculate the referral rate, divide the total number of referral links that have been clicked by the total number of sales made through those links.
The Importance of Cohort Analysis
Cohort analysis is a type of behavioural analytics in which users are grouped based on their shared traits in order to track and understand their actions. By using market segmentation, it is easier to ask more specific, targeted questions and make informed product decisions that can reduce churn and increase revenue.
Cohort analysis is also a way to measure the value of customers based on when they joined. This is important because it provides a better understanding of how long it takes for customers to bring a return on their investment. It also assists in developing customer retention strategies for crucial touchpoints in their journey, keeping them engaged and excited about what is being offered. This will help to develop more long-term value from customers and potentially attract new ones.
Identifying the Most Valuable Customers
Taking the time to identify how long the average customer stays with a company and how much they spend in the first few months is an important part of increasing LTV. Once the most valuable customers have been identified, one can examine the factors causing them to spend so much. These factors may include which parts of the marketing strategy they are engaging with, how often they return to the company website, how often they are making purchases, and so on.
Once this information is known, it can be used to tailor any marketing strategy to appeal to these individuals in order to derive the most revenue from them, as well as to design initiatives that encourage other customers to mimic their purchase behaviour.
Another relevant metric here is customer lifetime potential, which estimates the maximum amount of profit that a customer is likely to bring over their lifetime. It is based on several key factors, such as the customer’s current spending levels, their projected growth, and their likelihood of making repeat purchases. Customer Lifetime Value Potential is a helpful metric for marketers and sales teams, as it can help identify which customers to focus on attracting or retaining.
How to Develop LTV
There are numerous ways to develop LTV. Below are several strategies to consider.
Align with Customer Values
In times where customers expect a lot more from companies than a simple exchange of money for a service or product, brands must demonstrate certain shared values to increase customer loyalty. According to Harvard Business Review, up to 64% of survey respondents mentioned shared values as their primary reason for having a relationship with a brand. This indicates the importance of the organisation’s beliefs and morals, as well as an outward interest in philanthropy, social welfare, the environment, and so on.
Personalised Communication
Personalised communication is currently a top tactic used by brands desiring to increase their LTV. Any interactions between brands and customers which are tailored to individual preferences and needs can drastically increase satisfaction and loyalty, driving long term revenue. Some data suggests that personalised communication is more likely to cause impulse purchases in 49% of customers, after which, 44% will become returning customers.
Customer Experience
There is abundant evidence indicating that excellent customer experience is at the root of customer loyalty, which is a core component of LTV. In fact, 86% of customers are willing to pay greater prices for a greater customer experience.
There are numerous ways to create a memorable customer experience such as improving the onboarding process, improving customer care through using CRM software, developing a loyalty program, creating an omnichannel experience, and keeping up with technological advancements such as implementing voice search.
Creating an Omnichannel Experience
Today, customers are connecting with businesses through a vast array of devices and platforms. It has become crucial for brands to not only be reachable through as many of these channels as possible, but also to maintain a highly consistent user experience across all of them.
Many businesses are already aware of the benefits of this approach. PWC found, in its retailing report, that the number of companies investing in the omni-channel experience has jumped from 20% to more than 80%.
Leveraging Customer Insights
Using Customer Insights (CI) data to develop new products and amend existing ones is a highly valuable practice that can help to retain customers for the long-term. Understanding CI can also enable marketers to develop and deploy relevant communications at exactly the right time, and with greater refinement than if they did the same process without it.
It can be easy to make assumptions about what customers want from a brand. Harvard Business Review discusses several myths about customer engagement and how failing to recognise this causes companies to implement marketing strategies that have a low return on investment.
In their study, only 23% of participants considered themselves to have a relationship with brands they use, with members of the remaining 77% making comments such as “it’s just a brand, not a family member”, and that factors such as discounts and special offers were more powerful catalysts of loyalty. This is just one example to illustrate the importance of truly understanding what is going on in the mind of the customer.
Upselling and Cross-Selling
This is a simple tactic that can re-engage existing customers. Again, personalisation is important here, ensuring that customers receive relevant recommendations. Consider whether complementary products and services are truly going to bring value to the customer before attempting to entice them, and as always, ensure the post-sale experience leaves them satisfied.
In Summary
Retaining customers is vital in the current economic climate, and understanding how to optimise LTV is an important step to maximising retention. LTV data can provide insights into the time taken for a customer to bring a return on investment, as well as determining which customers are the most valuable and how to capitalise upon that. Market segmentation assists with developing relevant strategies that are likely to convert and increase LTV, in both the long and short-term.
There are numerous ways to increase LTV including upselling and cross-selling, augmenting the customer experience, personalising communication, and using CI data to truly understand what customers want.
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