How to calculate Customer Lifetime Value in Marketing

How to calculate Customer Lifetime Value in Marketing


What’s up y’all, this is Scott Davis and my
goal today is to make calculating customer lifetime
value accessible and maybe even enjoyable for you. I’ll refer to customer lifetime value by its
abbreviation CLV throughout this video. Let’s dig in. First, why is CLV important? CLV gets at the heart of marketing’s objective
to attract and keep profitable customers. You
need to understand CLV to put together effective marketing plans and make strategic decisions. How much money are you going to allocate to
attract new customers and generate leads? Attracting new customers might cost 3 or 4
times as much as retaining existing ones. CLV will
help you understand what kind of return to expect on today’s investments in customer
acquisition and retention. How are you going to stop customers from defecting? What aspects of customer attrition are
controllable? An average company loses 10 percent of its
customers each year. A better understanding of CLV will help you
manage these dynamics. Think of managing customers as managing a
leaky bucket. Your customers are represented by water and
the water already inside the bucket is your customer base. New customers added to the bucket increase
your customer base. Ah, But there’s also a hole near the bottom
of the bucket and the water leaking out represents lost customers. So in order to grow, your business needs to
increase the flow into the bucket by acquiring new
customers or decrease the customer outflow by retaining your existing customers, or both. It’s also important to note that not all customers
are profitable. Have you heard of the eighty
twenty rule? Eighty percent of company profits come from
twenty percent of its customers. Given our fight against the leaky bucket and
mixed profitability amongst customers, we need a
better understanding of customer profitability in the long term. Enter, customer lifetime value. CLV is calculated a number of different ways,
but let’s focus on the common features. We start with the top line, the company’s
expected revenues or sales in dollars over the
customer’s lifetime. We are interested in profit, so we also need
to subtract the expected costs including acquisition, sales, and service costs for
the customer. Have you ever watched the TV show Shark Tank? Notice that the investor’s financial questions
usually relate to the variables used in computing CLV. It’s not easy, but you can do it. Here comes some math. Let’s start with the most basic formula for
CLV. CLV=the annual profit contribution per customer
times the average number of years they remain a customer… minus the initial cost
of acquiring a customer… profit contribution is the
margin, or the amount of the sale that is not eaten up by variable costs. Other CLV formulas
account for fixed costs and the time value of money, but let’s start slow. Let’s walk through an example with our basic
formula. Suppose the average Starbucks customer spends
six dollars per visit and visits two hundred times per year. That is twelve hundred dollars in annual revenue
per customer. But the
contribution margin is only three dollars per transaction because of all the variable
costs that go into making a cup of coffee. So the annual profit contribution per customer
is six hundred dollars. We multiply the six
hundred dollars times the average number of years someone remains a customer at Starbucks. Suppose it is twenty years. Now have six hundred times twenty for twelve
thousand bucks. But it costs money to acquire
new customers, say five thousand dollars on average per customer for Starbucks. We subtract
that from our twelve thousand to arrive at a seven thousand dollar customer lifetime
value. This number is going to help us figure out
how much to pay to acquire and retain new customers. Beyond that, we can see how important it is
to sell more to our existing customers. Can we push the six dollars per transaction
higher? Can we stretch twenty years of loyalty to
twenty five? How much will that cut into our contribution
margin? We could also take a more nuanced view and
look at the impact of low and high profit customers. Did you know that different methods for attracting
customers have different CLVs? For example, Acquiring customers through deep
discounting can substantially reduce CLV. You need to be thinking about how much potential
your new customers have to become loyal to your business. Understanding CLV will help you set and evaluate
your pricing and promotion strategies. This concludes our first look at Customer
Lifetime Value. If you liked this video, please consider subscribing,
liking, and commenting. Thank you.

4 comments

  1. Hi Scott! 
    Would the cost of the coffee cups at Starbucks be subtracted from and figured into profit? Do you apply discounts into profit before you subtract? Or to marketing spend? And then profit (revenue-expenses) – marketing spend (banners, ads, etc.) * customer longevity= CLV?
    I love shark tank!­čŽł

  2. How did you calculate the Customer Acquisition Cost of $5000 (what are the components of that number ) ?

  3. So I am having trouble figuring out how I would calculate the LTV of high ticket customers. Like a decking company may build a deck for $5000 and that may be the average sale per customer for a whole yr. How do you calculate such a number with such low revisit frequency? I hope this question makes since. Thank you.

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