In an increasingly competitive business world, understanding the real value of customers is essential for long-term success. And for this reason, Customer Lifetime Value (CLV) plays a fundamental role, allowing us to measure the financial value that an individual customer will bring to a company throughout their relationship with it.
Customer Lifetime Value goes beyond the simple initial transaction and offers a comprehensive view of customer profitability over time. It helps to understand which customers are the most valuable, what strategies should be implemented to keep them satisfied, and how to maximize their loyalty. In addition, knowing the value of Customer Lifetime Value makes it possible to make more informed strategic decisions and to focus the company's efforts on those most valuable customers.
How to calculate Customer Lifetime Value?
The CLV calculation is based on a number of factors, such as the average number of purchases made by the customer, the average monetary value of each purchase, the length of the relationship with the customer and the customer retention rate. By analyzing these factors, we obtain an estimate of the total income expected to receive from that customer over time.
It should be noted that the Customer Lifetime Value (CLV) formula may vary depending on the approach and available data. When it is only necessary to calculate the total revenue that a customer will leave throughout their relationship with the company, the following formula can be used, based on the multiplication of three key elements:
- Average revenue per order (the average monetary amount a customer spends on each transaction or purchase). Both recurring purchases, additional services or any other source of income related to the customer must be taken into account.
- Average number of orders per year (how often a customer makes purchases in a year).
- Average length of customer relationship in years (average time that a customer maintains a business relationship with the company).
It is important to note that this formula does not take into account factors such as the costs associated with acquiring and retaining customers, the current value of future cash flows, or the impact of customer loyalty on CLV. Depending on the complexity of the analysis and the availability of data, more advanced and specific formulas can be used to calculate the CLV.
How to increase CLV?
Increasing Customer Lifetime Value is an important objective for many companies, since it involves generating more economic value in the long term. One of the main strategies that a company can carry out is to design and implement actions aimed at improving the three key factors of the basic CLV formula itself:
- Increase the frequency of purchases. The more purchases a customer makes, the greater their value over time. Some of the strategies to try to increase this frequency include: implementing loyalty programs, cross-selling or creating exclusive limited-time offers that motivate customers to buy immediately, among others.
- Increase the average value of each purchase. The average monetary value of purchases a customer makes is also a key factor. In this sense, some of the strategies to try to increase the average value of each purchase include: offering premium versions or packages with greater added value (upselling), offering volume discounts based on the number of products purchased or using data analysis to customize product or service recommendations for each customer, in order to show relevant and personalized products, based on purchase history and preferences.
- Increase the length of time the relationship with the customer lasts. Loyal, long-term customers have more opportunities to make additional purchases and generate ongoing revenue. To this end, it is essential to provide excellent customer service at all stages of their life cycle, to maintain regular and personalized communication, to establish follow-up programs and reminders and to maintain high quality standards in the product or service offered, in order to remain relevant in the lives of customers and meet their needs.
Those companies that include more variables in the CLV formula should design strategies to improve their value, such as: increasing the customer retention rate, increasing gross margin or reducing costs associated with the customer, among others.
CLV and other financial metrics
In the context of a company's financial performance, Customer Lifetime Value is closely related to other financial metrics such as Customer Acquisition Cost (CAC). The relationship between CLV and CAC is critical to determining the profitability of customer acquisition strategies. If the value of the CLV is greater than the CAC, it means that the value generated by a customer throughout their relationship with the company exceeds the cost incurred to acquire it, and that, therefore, the acquisition of that customer is profitable and contributes positively to financial results.
Conversely, if the CAC is significantly higher than the CLV, the company is likely losing money acquiring new customers. This can be problematic and require adjustments to acquisition strategies or to the company's overall approach. The relationship between the CLV and the CAC is therefore used to make strategic decisions in terms of allocating resources and evaluating the effectiveness of customer acquisition activities.
CLV, a basic metric for the marketing department
As we have already discussed throughout the article, knowing the value of Customer Lifetime Value is essential for companies, and especially for their marketing department, since it serves as a basis for analyzing what marketing strategies need to be developed and implemented, aimed at maximizing the long-term value of customers (loyalty programs, cross-selling and upselling, personalized communication, etc.). In addition, Customer Lifetime Value allows companies to segment their customers into different groups according to their potential value in order to adapt marketing strategies to each one and invest a budget appropriate to their value, optimizing available resources and prioritizing strategies that generate a higher CLV. Once the customer segments with the highest potential value have been identified, it is important to identify behavioral patterns and common characteristics between them, in order to identify new prospects with the potential to generate a high CLV.
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