In today's competitive business landscape, understanding the true potential of customer lifetime value (CLV) is essential. While CLV has long been associated with customer retention strategies, it's time to expand our perspective and explore how it applies not only to retaining but also to acquiring new customers.
Selling to your existing customers is undeniably more cost-effective than venturing into the challenging realm of customer acquisition, which can often come with a hefty price tag – up to five times more expensive, in many cases. But what if we told you that CLV holds the key to optimising both aspects of your business?
In this article, we'll explore the benefits of CLV, enabling you to unlock its full potential and develop an effective approach to customer engagement and growth.
What is Customer Lifetime Value (CLV)?
Customer lifetime value (CLV) is a metric that tells a business how much profit they can expect to make from a single customer over the duration of their relationship with the company. By analysing CLV, companies can gain invaluable insights into the long-term economic value of their customer base.
It considers what the customer has purchased, looking at their first transaction and repeat purchases. Understanding and measuring customer lifetime value provides valuable insights into your current level of customer loyalty.
When customers repeatedly make purchases from you, it typically indicates that your business strategy is on the right track. And repeat customers who are loyal will have a larger customer lifetime value than one-off buyers, meaning you’ll reduce expenses on customer acquisition.
CLV is an important consideration for both retention and acquisition. By understanding how to create value throughout the customer lifecycle, this can be applied to acquisition strategies in order to drive value from the offset of the relationship.
For support with your CLV, you could use a value based management platform to help find your most valuable customers.
Why is customer lifetime value important?
In a recent study, we found that 1 in 5 newly acquired telecom customers are “value-destroyers”. These are customers who reflect a high cost to serve, high cost of acquisition, and high churn rate. These are customers that businesses should avoid, but how do you identify them?
The answer lies in adopting more meaningful value-based models; ones that assess customer metrics based on value, rather than volume. Calculating CLP can help you make data-driven business decisions, leading to increased customer loyalty and reduced churn, and essentially help you work out the value that customers bring to your business.
Here are just some of the many reasons why CLV is important:
Increase revenue over time
The longer the duration of a customer lifecycle, the more revenue they will generate for a business. As a result, monitoring and optimising CLV can lead to increased revenue.
CLV serves as a tool to pinpoint the customers who generate the most revenue for your business. This valuable insight allows you to customise your products or services to cater to your top-spending customers, increasing the likelihood of keeping them as loyal customers who are engaged with your brand.
Boost customer loyalty and retention
Research shows that it’s often more cost-effective to retain existing customers than to acquire new ones. Harvard Business Review reports that customer acquisition efforts can cost five to twenty-five times more than customer retention. Additionally, research by Frederick Reichheld of Bain & Company finds that just a 5% increase in customer retention is capable of producing more than a 25% increase in profit.
Reviewing CLV can help you spot any areas that need addressing so you can create solutions to resolve them.
Target your most valuable customers
If you know how much a customer is likely to spend with you, this can help you develop a customer acquisition strategy. By allocating your marketing resources more efficiently, you can focus on customers with high CLV to maximise returns. One study found that existing customers are 31% more likely to spend more on their average order value than new customers highlighting their value.
Attract new customers who are likely to stick around
Once you know what your existing customers' favourite products/services are, you can target your marketing efforts around this to attract new customers who have similar shopping habits. Acquiring new customers is more expensive than retaining existing ones and with any new customer you acquire, you want them to become a repeat buyer so you’re getting the maximum return for your marketing efforts.
You can look into the buying habits of your longest tenured customers to see exactly what products they purchased at the beginning of their journey with you and how that has progressed over time. This can give you an idea of what campaigns or promotional offers you could run to acquire new customers who have the highest potential to become long term customers.
Product and service improvement
CLV can provide insights into customer preferences and pain points. Analysing the behaviour of high-value customers can provide businesses with valuable information into what products and services could be improved to increase customer satisfaction.
How to calculate customer lifetime value
There are two models that businesses will use to measure customer lifetime value; the predictive model and the historical model.
Predictive customer lifetime value
The predictive model is used to anticipate the purchasing behaviour of both new and existing customers by utilising regression or machine learning techniques.
It can help you to better identify your most valuable customers as well as the product or service that generates the highest sales. You can maximise customer retention with this information by targeting your marketing efforts and product/service variety to ones that both new and existing customers are more likely to buy.
Historical customer lifetime value
The historical model uses past data that has been collected to predict the value of a previous customer regardless of if they will continue to buy from you or not.
It relies on the average order value to assess the worth of your customers. This model proves particularly valuable when the majority of your customers engage with your business during a specific timeframe.
The weakness to this method is most customer journeys tend to differ. Active customers could become inactive, while inactive customers could return, all of which can skew your data.
Tips for increasing customer LTV
Here are some helpful tips to increase your customer lifetime value:
Improve customer onboarding process
They say it takes 7 seconds to form a lasting opinion, so consider how your onboarding process leaves a lasting impression on new customers. Make sure to keep the initial stages of the customer journey simple, yet distinctive. For example, you could offer personalised item selections or attractive deals for a customer who has recently made a first time purchase. You can also follow up with emails to ensure that their initial purchase meets or surpasses their expectations. This can help you enhance customer satisfaction and foster long-term loyalty, increasing CLV.
Encourage them to spend more
Boosting CLV can be achieved by increasing your average order value. A great way to do this is by upselling.
When customers are on the verge of checking out, you can present them with relevant products that compliment their intended purchase. Amazon is a good example of a company who successfully upsells, offering related products in bundles.
If your business operates on a subscription-based model, you can increase both your average order value and customer lifetime value by encouraging customers to switch to an annual billing cycle, optimising revenue potential and strengthening customer loyalty over an extended period.
Be honest with what you’re selling
Trust is the most important element for a long-lasting customer relationship. When your customers have confidence that your company will deliver what they want at a price they think is fair, they’ll be more likely to return. That very first purchase they make with you needs to go well. If the customer experiences any problems with the product or service they are unlikely to return.
Ensure you are fully transparent with your products and services so customers are not disappointed with things or feel like they’ve been lied to. If it doesn’t work as advertised, this can result in negative reviews which can damage your brand's reputation and put off any prospective buyers.
Build relationships that last
Social media has changed how marketing works, and many customers are expecting more than just a transactional business relationship. They want a personal connection, so it's important to engage with customers, giving life to your brand as a personality, not just a corporate entity.
You could conduct some social media research to understand your customers better. This can help you identify their interests and preferences, allowing you to offer a personalised touch which can help forge an actual connection, which can be the difference when improving CLV.
Provide the best customer service you can
Having good customer service is very important to most customers. If you don’t respond to customer queries and complaints, they’ll be very unlikely to buy from your brand. This applies to both new and existing customers. A new customer may want additional information from you so it’s important to answer their questions to increase the chances of them making a purchase.
Ensure you are actively checking messages from customers and have a return or refund policy in place. This helps customers to trust you knowing that you stand behind your own products or services and will refund if you fall short of the standards you set. Showing you care about customer satisfaction is an excellent way to increase CLV.
What are the challenges of CLV?
Measuring customer lifetime value comes with its fair share of challenges.
Firstly you need to decide if you are calculating the average customer lifetime value across your entire customer base, or if you’re focusing on individual customers or customer segments. The issue with taking averages is that it can often obscure the true picture.
For many companies, their top 20% of customers generate 80% of revenue. While the specific numbers will vary across clients and industries, the bottom line is that significant disparities exist in customer value, purchase frequency, and the duration of customer relationships.
The second challenge lies in determining the length of the customer relationship. This will vary from each industry, for example the automotive industry has a long purchase cycle, as a customer will buy a car that they will use for multiple years. You need to decide whether to calculate the customer relationship based on consecutive purchases or the actual lifetime of the customer. This decision will impact the accuracy of how you calculate your CLV so it should be carefully considered based on the context of your business.
Other challenges include data quality and availability of data. If you don’t have enough customer data, which can be common for new businesses, it can make it very difficult to calculate CLV. If your data has not been stored in an efficient way, it can make it very hard to interpret.
If the quality of the data is not trustworthy and has mistakes or is incomplete, it can severely impact how effectively it can be used to calculate CLV.
Final thoughts
Understanding how to calculate Customer Lifetime Value (CLV) is a critical aspect of creating a successful business strategy. CLV provides valuable insights into the long-term value of each customer, enabling businesses to make informed decisions and optimise their marketing and customer retention efforts.
Our powerful value based management platform helps identify your customers that provide the most value so you can make informed business decisions at a granular, customer level. Go beyond averages with value based management, giving you an understanding at customer level enabling you to roll up to any combination of customers segments to drive actionable insights, maximise your profit, and support strategic initiatives.
Get in touch to find out more about how we can help you with your CLV needs.
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