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What is Customer Lifetime Value (CLV or LTV)?
Customer lifetime value (CLV or LTV) or is the value (i.e. revenue or profit) a customer generates throughout the entire duration of the customers relationship with the firm. There are various models available to predict the lifetime value of a customer and the value itself differs based on the model used. CLV helps us in understanding the value of a customer in monetary terms.
The concept of customer lifetime value (CLV) focuses more on the long term value of a customer and not on the quarterly value. In this sense this is a very important concept. The are many industries (for example, e-commerce or social media) where a customer may not generate any profit for the firm in the short run but become very valuable in the long run.
Customer lifetime value is also important because it allows us to put an upper limit on the cost to be incurred to acquire the customer. And we can use this maximum customer acquisition cost to estimate our advertising spend.
How to Calculate Customer Lifetime Value
Calculating customer lifetime value requires you to first ascertain the different variables and constants required for calculation. These generally include
- Gross revenue per customer in a week or year
- Average purchase cycle, i.e. the number of times a customer purchases from you in a week or year
- Average customer lifespan i.e. how long a person remains your customer
- Customer retention rate i.e. the number of customer who are retained in a period compared to the previous period.
- Profit margin per customer
Given below is an infographic from Kissmetrics, which explains the methodology of calculating customer lifetime value in details using the case study of Starbucks. It also explains how you can break down the figures of CLV further and calculate the CLV of a good (or high paying) customer vs. an average customer. This will help in determining how much extra should you pay for acquiring such good customers.
(Click on the image to zoom it further)