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Customer Journey

Ignore your customer lifetime value at your own peril

Written by Tony Loxton
Jun 16

Knowing which marketing metrics to pay attention to, and those which are merely superfluous can be tricky. After all, the data that’s most useful to your business might be very different to the information coveted by another. The one metric that all marketers need to know? Their customer lifetime value.

The reason is simple: not only does this give you insight into budget allocation and marketing strategies, in working out what your CLV is, you’re privy to other crucial metrics that can help you to increase your customer retention rate, attract new customers and better serve existing customers to boot.

Or so says venture capitalist David Skok in his blog For Entrepreneurs. His argument is convincing: if you don’t know what your CLV is, there’s a good chance that your Customer Acquisition Value (CAV) outweighs your CLV. Which means that your business model is essentially unbalanced, and therefore unsustainable. This happens, writes Tommy Walker, “because so many businesses focus on transactional customer value, and forget to invest in the experience that happens after the conversion.” And if you’re allocating a significantly higher amount of capital to customer acquisition, and neglecting their after-sale experience, you’re entering a vicious circle that calls for more and more investment in CAV – a practice that’s far from sustainable. And as Walker points out, while investing in product innovation is important, if you’re not also focusing on making your existing customers’ experience better, or marketing to them, your CPA can very quickly amount to more than your CLV. Now that we’ve established why you need to know your Customer Lifetime Value, let’s discuss how to go about it.

The first step in determining your Customer Lifetime Value is to calculate your Cost per Customer (CPC).

If you’re not already measuring these metrics, Walker suggest the (albeit simplistic) model of:

Marketing spend divided by total number of customers equals cost per customer.

Alternatively, marketing automation software Hubspot advocates this model that breaks your CPC into three: Cost of Customer Visits (CoCV), Cost of Lead Acquisition (CoLA) and Cost of Customer Acquisition (CoCA.) Walker puts this into context with this example:

“Let’s say you spend $1,000 in PPC, which nets you 500 visitors. At this point, you’re paying $2/ visitor. If 5% of those visitors convert to leads (CoLA) than your cost of lead acquisition is $40 (2/5%). If 10% of those leads convert to customers, than your cost of customer acquisition (CoCA) is $400 ($40/10%)”.

The next step in uncovering your Customer Lifetime Value is establishing your Customer Retention Rate (CRR).

This part of the equation is only viable if you’ve been in business for a couple of months at the minimum, as before you can work out your CLV, you need to know how long your customers are actually staying customers. To work out your Customer Retention Rate, Walker suggests the following method:

The number of customers at the end of the period (E)

The number of new customers acquired during that period (N)

The number of customers at the beginning of the period (S)

And this formula: CRR = ((E-N)/S)*100

Walker explains: “...let’s say you started the quarter with 200 customers (S), you lose 20 customers but gained 40 customers (N) so when the period was over you had 220(E).
Using the formula we’ve got ((220-40)/200)*100=90 or in other words, a 90% retention rate.

Take note, Walker emphasises that this formula should not be applied to find a blanket average across your entire customer base. Instead, you need to do some smart market segmentation beforehand.

Don’t forget about the churn.

Every business loses a certain number of customers, no matter how great your product or service is. In order to get to the most accurate CLV possible, you need to take customer churn into account in order to make sure your CRR isn’t skewed. Walker suggests this formula:

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Source

Once you’ve crunched the numbers above, you can calculate your Customer Lifetime Value.

There are several methods and formulas to get to the holy grail of marketing metrics, your CLV, but for simplicity’s sake, Walker recommends this formula:

(Average value of a sale) X (Number of repeat transactions) X (Average retention time in months or years)

Let’s say you’re in the business of selling gas barbeques and gas canister refills. You average sale is $200, and your customers contact you for their annual refill, which is approximately three years running until they replace their model with one from another competitor.

Your Customer Lifetime Value is then $300 x 3 x 3 = $1800 – not bad, but again, this is an average representation. You may have some customers buying refills for models purchased elsewhere, which means they never fork out for the actual barbeque, and you might have some customers who buy the barbeque but get their refills somewhere else. In addition, you may have some customers who also pay for the maintenance of their barbeques on top of their original purchase and annual gas canister refills. Once again, market segmentation is an incredibly important factor in calculating the true metric, and while this formula is useful, your specific business model and customer behaviour may call for a slightly different method. (You can read more about these here.)

Did you know that Blix Traffic helps you to identify this crucial metric? Find out more about how you can use Blix Traffic to gain deeper insight into your customers and their interaction with your brand, here.

 Learn more about Blix Traffic for retail

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