Customer lifetime value

It’s a well-worn maxim that your customers are your most valuable asset, but how can you know their worth in concrete terms?

Customer lifetime value (CLV) is a metric that calculates just that. It estimates the total value a business can expect to earn from a customer throughout their relationship.

Anton Ovchinnikov, a professor of management analytics at Smith School of Business at Queen’s University in Kingston, sees two clear choices when it comes to building relationships with your customers:

• Invest in  providing great service to attract loyalty, or
• spend little to get a higher immediate profit, but risk losing customers to other providers.

“How do you maintain those relationships? By giving customers good service. That might be through discounts, rewards or early-bird access to new products. Your margins will be smaller, but the lifetime of that customer will be longer,” says Ovchinnikov, adding that giving bad service and charging high prices raises the risk of not having a long-term relationship with that customer.

How do you calculate customer lifetime value?

CLV calculations are unique to each customer and take into account their purchase value and lifetime with the company. But the type of client is one part of this calculation; the other includes how much has been spent by the business to retain that individual customer.

Customer retention spending usually includes things like:

• loyalty programs
• special discounts
• hiring more staff to improve customer service

The example below illustrates how spending more on customer retention can result in long-term gains for the business despite the immediate expense. Let’s say Business A spends $100 a year to help keep a customer, while Business B spends $200.

Although Business A appears to have saved $100 a year, it actually earned less money on that customer overall than Company B earned on that customer. This is even though Company A’s customer spent more ($900) than Company B’s customer ($800).

This is because of what’s known as the retention probability, which has been shown to increase as you spend more money to keep your customers happy. A $200 investment translates into a much higher probability that your customer will remain loyal. In the case of Company A and Company B, we see that the lower 50% retention rate cuts the yearly expected purchases by half, as opposed to the 66% rate, which only cuts them by a third.

Therefore, Business B will have twice the number of years to recoup the money it spends, recovering more value from the customer relationship in the long term. Every year of diminishing returns is then added up to arrive at the final dollar figure of the CLV.

Why is customer lifetime value important?

Customer lifetime value can play a large role in budgeting. Having a CLV allows you to better assess how much to spend on acquiring and retaining customers, whether that’s through marketing, service or pricing. If you know how much long-term value a customer can bring to your company, you’ll be more comfortable working on cementing your relationship.

CLV is all about relationship building, says Ovchinnikov. “Customer lifetime value encourages businesses to stop thinking about transactions and start thinking about relationships instead.”

You’ll need to differentiate your customers

Calculating CLV requires reliable customer data. You’ll also need purchasing records that differentiate one customer from another.

Ovchinnikov says robust internal data is a must for calculating CLV. It is important for all businesses—even small ones—to capture customer information on their transactions. There is much affordable current software to help businesses do this.

Once you have a few years of data, he says it can be fed into an AI program that can separate what customers bought for how much and how long. After that, you can make the above CLV calculations.

Not all customers have the same lifetime value

Ovchinnikov brings up two examples of customers that would likely have a higher value than others: influencers and, in some circumstances, university students.

One could argue that influencers with large followings warrant more attention from businesses. “An influencer has a connection with other potential customers,” says Ovchinnikov.

Students, or those at the beginning of their relationship with a business such as a bank, might also be worth investing more in. Ovchinnikov brings up the example from a few years ago of a Canadian bank offering free computer tablets to new student clients. He says that the bank likely saw it as a justifiable expense since the value of the students who stayed with the bank would more than cover the cost of the tablet. “CLV helps balance how much customers will spend—and how long they might stick with your business—in the future versus the cost to acquire them today.”

10 tips on how to increase customer lifetime value

The following tactics can help increase CLV in your business and improve long-term growth.

Enhance customer experience

Personalize services and communication to make customers feel valued. Excellent customer support and simplified processes can increase retention.

Build strong relationships

Engage with customers regularly through emails and social media. Implement loyalty programs and seek customer feedback to improve your offerings and encourage repeat business.

Upsell and cross-sell

Offer premium products or complementary items based on customer needs, providing more value and increasing their spend.

Create subscription or membership models

Offer subscription services or exclusive memberships for ongoing product access to ensure a steady revenue stream and foster long-term relationships.

Offer high-quality products/services

Consistently deliver quality that exceeds expectations, leading to customer satisfaction, repeat business and recommendations.

Retargeting and re-engagement

Use email campaigns and retargeting ads to re-engage inactive customers with personalized offers.

Build a community

Encourage customers to advocate for your brand and create referral programs, helping bring in loyal, long-term customers.

Innovate

Regularly update your offerings to stay relevant and adapt to customer needs.

Offer payment flexibility

Provide payment options like installment plans to make purchases more manageable and offer discounts for long-term commitments.

Focus on retention

Invest in customer retention programs and win back lost customers through personalized outreach.

Next step

Track and analyze data to take the guesswork out of business planning by downloading BDC’s free guide, Monitoring Your Business Performance.