What is CLTV*?
One of the most important ways to analyze your business is to calculate the average revenue a customer will spend during the period customers stay loyal and purchase from your store.
A supermarket will want to know what the customer lifetime value is so they can predict and decide how much marketing budget to spend.
Software companies will also want to know their CLTV so they can decide how many customers they’d need to become profitable.
Even your bank will want to know you CLTV if you need a business loan.
So, there are many reasons why improving your CLTV is extremely important.
* Customer LifeTime Value is abbreviated as CLTV, LTV, CLV or LCV. Welcome to the world of abbreviations 🙂
The simple way to calculate CLTV
- This can be done by dividing your revenue (usually 12 months) by the number of transactions during the period you used to accumulated revenue.
- Calculate average order frequency: This can be calculated by dividing the number or purchases with a specific time-period and divide it by the amount of unique customers.
- Calculate customer value: You can find the number by multiplying the average order value by the average order frequency.
- Calculate average customer lifetime: You need the average number of years a typical customer has purchased. Because some e-shops offer to purchase without registration, I recommend not to consider them in the calculation.
- Finally you can calculate the CLTV by multiplying the customer value by the average customer lifetime. This calculation will give you a reasonable exception of how much revenue a customer will bring to the table.
CLTV calculation example
Let’s take to calculate the CLTV of a local furniture store.
According to your online database, the average customer spends $2000 during a specific year.
Customers visit the store twice a year (order frequency rate). The average order value (AOV) is $1000.
Now we need to determine the lifetime value expectancy of the average customer. Because this number is tough to predict, especially if you just opened your business, it’s better to be conservative with this number. Let’s say the average customer has a lifetime value of 5 years.
Now we have all the information plotted we can finally calculate the CLTV.
The CLTV with this imaginary case = 2 (order frequency rate) x $1000 (AOV) x 5 (years) = CLTV $5000.
You could also calculate your CLTV by using your average margins as the average order value. For e-shops selling thousands of items this can be cumbersome but for other e-tailers with just a few products calculating margin would be more sensible.
The best way to calculate your CLTV
This video is incredibly detailed how to calculate a CLTV expection for the next 5 years. I re-created the exact samen Excel including the formula for you to download.
Why calculating margin is better than revenue
You can’t go to the supermarket and buy food with impressive revenue numbers. You can only buy groceries with a result of the margin.
Margin is what’s left after you have deducted all the costs to create and sell the product. In other words, more margin = more cash in your pocket.
This is why the excel above is much more detailed and even though it’s a five year forecast it will help you monitor what matters most.
How to improve CLTV
Now that you are aware of your CLTV, you will want to improve that number gradually because doing so will provide additional revenue.
There are a few ways of accomplishing this goal, and I recommend creating a strategy document for this.
The reason why you would want to add this to your strategy document is so you don’t forget the conclusions and ideas you made in the past.
Remember the furniture store case above? The average purchase frequency was two purchases a year.
Let’s say we introduced a special discount day for clients who have been buying our products since we launched the store. What would this special day do in terms of your CLTV?
Furthermore, it’s much cheaper investing in the clients you already have than trying to convince new customers to buy your products. So 1 free tip is to embrace your clients and satisfy them.
Customer retention takes much more creativity and thinking power than spending money on advertising, crossing your fingers and hoping for the best. The outcome of a well executed customer retention plan will benefit your business longer.
You now know what CLTV is, how to calculate it (a big thanks to the video) and what the next steps you should be taking.