Exploring the Importance of Customer Lifetime Value

In today’s market, repeat revenue and long-term customer loyalty are much more important than acquiring new customers. That’s why assuring customer loyalty has become critical. However, achieving customer loyalty requires a certain level of investment and measurement. Take a look below to learn about the importance of customer lifetime value, along with how you can use it to plan for investment, cashflow, consumer behavior and even segmentation.

Customer Lifetime Value Goes Beyond Total Spend

There are good bottom-line-based reasons to understand the importance of customer lifetime value. With customer acquisition costs rising perpetually with the cost of advertising and marketing, it no longer makes sense to operate a business model that relies on customer acquisition.

Understanding what your customer lifetime value is on a broader perspective is important for calculating your costs and return on investment in general. However, on a more granular level, the importance of customer lifetime value becomes even more apparent. Once you calculate CLV on a more granular and individual basis, you can use it for optimizing customer journeys, customer segmentation, return on investment calculation and more.

The best part is that focusing on customers with the highest CLV, or the highest purchase frequency and average purchase value aggregate, means you're also focused on your most loyal customers. These customers have value that goes far beyond the traditional understanding of customer lifetime value. Loyal customers will contribute inordinately to your business through referrals, brand advocacy, positive word of mouth, even brand image and network effects in certain instances.

Long lifespan customers also provide data, and, in the heyday of analytics, data is gold. Detecting customer trends via analysis of long-term customer data is an inestimable resource for marketing and product planning.

How to Calculate Customer Lifetime Value

The basic, bottom-line value of any customer is important, whether they're with you for a long or short period. Customer lifetime value is ultimately determined by multiplying average customer value by average customer lifespan. By comparing the result for different periods of time, you can learn how to gauge the value of customer loyalty.

We recommend calculating customer lifetime value using the 5-step method outlined here.

What Does Customer Lifetime Value Mean for Me?

Knowing your customer lifetime value both on an organization-wide basis and on a more granular is essential in making more informed decisions on both a financial and marketing front. Knowing your customer lifetime value allows you to invest more smartly in customers that exhibit loyalty, while you remain aware of customers that should not be invested in.

Knowing your customer lifetime value is like knowing your ROI before even making an investment - if you do it correctly and have a lot of data on your customers. Using your data to detect who your most and least lucrative customers are enables you to drop acquisition costs while increasing the efficacy of your marketing approaches.

Why is Customer Lifetime Value Important?

Measuring Marketing Efforts

Calculating customer lifetime value and changes within it allows marketers to gauge the impact of their marketing campaigns and other marketing efforts. Simply comparing prospective customer lifetime values - on an aggregate basis - from before and after the campaign will give insights into the efficacy of the campaign and the impact it had on customer lifetime value.

Not only is this a big help in determining what works and what doesn't, but it also helps with planning. Provided you have enough customer data, you can calculate predictive customer lifetime value, which will allow you to gauge whether or not you should pursue a certain campaign.

Understanding Customer Behavior

Using your customer lifetime value data can be a significant help in understanding customer behavior. Comparing the CLV of different customers at different times can expose insights into customer behavior. Not only this, but it can also help to uncover reasons for certain increases or decreases in revenue and sales within a given period.

This relates to measuring marketing efforts, as these can also be a reason for revenue fluctuations - profitable ones, we hope.

Understanding Marketing Objectives

For many companies, measuring and understanding customer lifetime value will bring a new perspective to marketing objectives and strategy. The importance of customer lifetime value is exposed within decisions on when to invest in certain customers, when to drop investments in other customers, and also follow how successful respective campaigns and efforts have been in increasing CLV.

However, merely knowing what your CLV is isn't enough. Neither is understanding CLV. Prioritizing customer lifetime value and maximizing it is the approach that marketeers should be taking. This means prioritizing repeat customers and customer retention - which means targeting customers that most likely already have a high CLV, whether it's historic or predictive.

Retention over Acquisition

When it comes to making intelligent financial decisions, customer lifetime value is vitally important. Every company exists on making sales at a rate that is profitable and offsets their expenses. Unfortunately, too many companies have focused on the volume of sales they can make and not focused enough on what the most lucrative sales would be.

When looking at the most lucrative sales to make, however, existing customers are always a priority. When it comes to sale likelihood, it's 60-70% for existing customers and only 5-20% for new customers. This is a no-brainer, as the entire sale is contingent upon acquiring a new customer in the first place. When targeting existing customers, the investment is lower, and the process of convincing them that your product and brand are worth looking at was done long ago.

Segmentation

Different strokes for different folks. Not every campaign or marketing strategy works on every customer. When it comes to customer acquisition, certain campaigns are more effective, while other campaigns will be more effective when it comes to reactivating dormant customers or incentivizing existing customers.

The importance of customer lifetime value in segmentation is quite significant. Predictive customer lifetime value calculation is essential when it comes to customer acquisition campaigns, while either historic or predictive should be employed when it comes to deciding the investment in campaigns targeting existing customers.

Measuring Customer Loyalty

Although a relatively shallow measure of customer loyalty and brand loyalty, customer lifetime value is somewhat of a measure of customer loyalty nonetheless. Two vital components of customer loyalty are purchase frequency and average purchase value or spend, which are looked at within customer lifetime value calculations.

Customer loyalty - arguably even customer lifetime value - goes far beyond just purchase value and purchase frequency. However, in the most basic sense of customer loyalty, customer lifetime value is a considerably useful way of detecting when a given customer's loyalty begins to drop off.

Spot your Gaps

Like we said, customer lifetime value can essentially be cut in two - purchase frequency and average purchase value. This can be extremely useful when detecting which customers are starting to deteriorate in terms of loyalty. Not only this, but being able to detect this afford you the opportunity to target them more effectively.

Noticed a drop in purchase frequency? If you can detect an obvious reason for this, there's no reason to panic if the average number decreases. The same goes for average purchase value. Examine why purchase value has decreased. Is it because they've stopped purchasing a high-value product? Or has their basket size decreased overall? Whether purchase frequency or purchase value is lacking, you can gear your rewards to incentivize what matters most for you business.

ROI and Budget Allocation

We've already briefly touched on budget allocation in the topic of segmentation. Targeting certain customers will lead to a much more effective budget allocation, which should ultimately increase your ROI.

This is the greatest benefit of knowing your CLV, but seems to be largely overlooked. Spending some time on understanding your CLV on an organization-wide basis, as well as on a segmental basis, will drastically improve your return on investment, which leads to more profit that can then be reinvested in CRM efforts and better customer service to maximize lifetime value across your customer base.

Cashflow & Planning

Nobody can survive without cashflow. However, as the last 2 years have taught us, you sometimes have to. Although this, again, requires relatively deep analysis, going in-depth with your CLV analysis can help significantly with planning and forecasting.

Fluctuations in cashflow can be of huge detriment to your business, so being prepared for them should be a priority. Predictive CLV calculation, along with RFM analysis, will allow you to predict and protect yourself from cashflow dips or imbalances in the future.