Customer Lifetime Value: Useful Formula

Kim Chan

14 years ago

In my last blog post discussing the customer lifecycle value (CLV), I mentioned that the CLV is used to calculate the customer lifetime value, and promised I would elaborate on it.

Understanding the customer lifetime value

The customer lifetime value is a relationship marketing calculation that measures the anticipated length of a business’ relationship with a customer, combined with the anticipated customer financial value. The result is a prediction of how profitable that customer will be. This is an appealing marketing technique, as it allows companies to calculate how much a customer is worth, and how much a marketing department should be willing to spend to acquire each customer. Knowing this, a company can determine whether they are selling a repeat product or service, and can therefore maximize customer retention.

To clarify, take these two scenarios:

1. When many businesses look at a customer, they see the value of the first sale. If a customer buys a product worth $40, many companies would see the customer as being worth $40 in revenue. Then, if that same customer buys another $40 product from the same company, they will be seen as worth $80 in revenue.

2. More experienced businesses know better than to follow the above model. They know that the true value of the customer is the value of all the purchases the customer has made plus the value of all the purchases they are likely to make in the future. This is called the customer lifetime value.

Calculating the customer lifetime value

To calculate an estimated customer lifetime value, you need to multiply the average sales by the average number of times they come back. There are many formulas that can be used to calculate the customer lifetime value (such as the one on the right), however, the easiest one is: CLV = m(r/(1 + d – r)), where m = margin or profit from a customer in one year (revenue – product or service costs – cost of servicing, which includes acquisition and promotion costs), r = retention rate and d = discount rate (also called cost of capital or hurdle rate). If you don’t know what your company’s discount rate is, your CFO will likely be able to give you the number. If not, you’ll usually be ok using a value between 8% and 15%.

Calculating the customer lifetime value will help your company determine which customers to pay attention to, and which to forget about. Customers with a customer lifetime value less than zero is costing your company money; these customers should promptly be forgotten about.

Increasing the customer lifetime value with OneDesk

Seeing that the customer lifetime value is partly characterized by customer value and customer retention, your company must focus on increasing repeat business.

OneDesk helps drive customer retention, for it allows you to do the following:

Understand what customers want
With the customer feedback application, customers can submit feedback directly to companies, vote on feedback ideas, and engage in discussions with company executives, or amongst themselves in order to clarify their exact needs.

Be reachable and available to answer customer questions
OneDesk makes it easy for customers to communicate with companies and vice versa. Its social collaboration tools such as discussion forums and chat make for an inviting and collaborative environment.

Personalize customer relationships and communications
With OneDesk, companies can hold one-on-one discussions with customers. This builds customer relationships by enhancing the customer experience.

Try OneDesk for free today.