Customer Lifetime Value
Customer Lifetime Value (LTV or CLV) is a marketing concept used to calculate how much money should be spent to maintain customers and acquire new ones. For example, if the average new customer costs $100 to acquire and their lifetime value is $200, the customer can be considered profitable and additional similar customers would be worth acquiring for your business.
Customer Life Time Value is also used to:
- Manage customer relationships as an asset
- manage strategies, management and marketing investments on the value of the customer asset
- maximizing marketing return
- developing tools for strategies to target new customers and develop customer specific marketing strategies
- measure customer loyalty
Formula to determine Customer Lifetime Value
The formula to calculate the CLV is not a complicated one:
CLV = (Average Profit per Customer Purchase) * (Average Number of Purchases per Year) * Average Customer Lifespan
There are other variations on this formula, but this seems the easiest to work with for a convenience store.
To be more accurate, you’ll need to adjust for customer Churn. ‘Churn’ is the term used for the average number of customers lost, for any reason, each year. A more accurate formula would be:
CLV = (# of Customers) x (Average Profit per Customer Purchase) x (Average Number of Purchases per Year) / (Average Annual Customer Churn)
For the purposes of this example take the Customer Lifetime Value formula and suppose the following:
# Customers = 1000
Average Profit per Customer (in a given week) = $5.00
Average # of Purchases = 52 (assuming one purchase per week)
Average Annual Customer Churn = 10% or 100 customers per year
For the purpose of this example the lifetime is considered to be 10 years
(# of Customers) * (Average Profit per Customer Purchase) * (Average Number of Purchases per Year) / (Average Annual Customer Churn)
1000 * $5.00 * 52 / 100 = $2600 Year 1
Remember that this value will decrease each year because of the annual customer churn, unless the number of customers is maintained or increased every year. In following years the numbers in the formula look like this:
900 * $5.00 * 52 / 100 = $2340 Year 2
800 * $5.00 * 52 / 100 = $2080 Year 3
700 * $5.00 * 52 / 100 = $1820 Year 4
600 * $5.00 * 52 / 100 = $1560 Year 5
500 * $5.00 * 52 / 100 = $1300 Year 6
400 * $5.00 * 52 / 100 = $1040 Year 7
300 * $5.00 * 52 / 100 = $ 780 Year 8
200 * $5.00 * 52 / 100 = $ 520 Year 9
100 * $5.00 * 52 / 100 = $ 260 Year 10
The actual Customer Lifetime Value in this example (assuming no efforts to replace customers) is about $1430 per customer.
What Does This Mean To Your Store?
Enough of the math lesson; how does this benefit your store?
Even if your customers love you and your store and wouldn’t shop anywhere else, you can’t control the loss of customers who pass away or move away from town. But you can add new customers. Maybe you’ll be lucky and they’ll discover your store by accident and shop there forever, but more likely, you’ll be competing with the store across the road, which is also facing customer attrition.
The important thing here is that you have a tool to use to measure the impact on your business, and to develop a strategy to maintain or even increase your annual and lifetime profits from your store.
How Can You Use This?
By analyzing the numbers, and using the formula, you can see that reducing your customer churn, or turnover, by 50% will reduce the potential lost income from $26,000 to $13,000. This is an extra $13,000 per year to your bottom line or $130,000 over ten years.
- Customers stop doing business with a company for a number of reasons. By becoming aware of the Customer Lifetime Value, you are better able to see how each customer contributes to your overall success. There are difficult customers in every business, but it is almost always cheaper to keep a customer than to get a new one. Work hard to keep your customers.
- Be sure that your employees realize the value of each customer to your business. Making sure that your customers feel welcome and valued is one of the most important parts of any employee’s job. The employees are there to serve the customers and ultimately your business; they should not act like a customer is inconveniencing them. This is probably happening far more than you realize.
The Customer Lifetime Value formula also shows that you can increase your annual and lifetime profitability by:
- Increasing the number of customers
- Increasing the profitability of each sale or
- Increasing the number of sales.
If you know that the average customer lifetime value is $1430 from the example above, you don’t want to spend more than $1430 to acquire that new customer. You can plan your and marketing and media strategies based on this information and budget accordingly.
This all seems pretty obvious, but by using this tool you can plan how you will put you these strategies into action, and measure your success against your goals.