Understanding Customer Lifetime Value

When we begin the process of creating a digital marketing strategy, we spend a LOT of time learning about our client before we start discussing strategic directions. We learn about their challenges. About what makes them different. About their competition. About their goals. And about their current and potential customer base.

That last part might be the most important. You might have heard the terms 'target audience,' or 'ideal customer' or 'buyer persona.' They all refer to the same general concept: who are your customers?

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We’ll get more into what goes into creating a buyer persona in another blog. But one of the most important parts of understanding your ideal customers and how to reach them is to know the value of each type of customer to your bottom line. Unless you know that, it can be very difficult — if not impossible — to build a reasonable marketing budget, create a sound marketing strategy, and prioritize various marketing tactics.

It’s called the customer lifetime value, and it is simply the measure of the profit your business makes from any given customer. And as you work to grow your company, there are few metrics more important to have a handle on. If you know the customer lifetime value and the cost of acquiring that customer, then you can determine how long it will take to recoup the cost of earning a new customer.

It also helps you make a number of important strategic decisions about marketing, customer support and other elements of your business. Armed with an accurate customer lifetime value, you are better able to determine how much you should spend to acquire a new customer vs. how much you should spend to retain an existing customer. It will also help you determine what types of customers you should invest more of your marketing dollars and time on trying to acquire.

Without this information, you might not be deploying your marketing budget as effectively as possible. You might not be investing enough of your resources on your highest lifetime value customers and/or you might be investing too much into acquiring new customers with very small margins, or, worse, even losses!

So, how do you calculate the lifetime customer value? Use this formula:

  1. Calculate average purchase value by dividing your total revenue for a certain type of service or product you provide in a time period (usually one year) by the number of purchases over that same time period. So, if your total annual revenue was $100,000 for Product A, and your number of purchases for Product A was 300, your average purchase value would be $333.33.
  2. Calculate the average purchase frequency rate by dividing the number of purchases over the time period by the number of unique customers during that time period. So, if you had 300 purchases by 200 unique customers, your average purchase frequency rate would be 1.5.
  3. Calculate customer value by multiplying the average purchase value by the average purchase frequency. So in our example that would be $333.33 x 1.5 = $500.
  4. Calculate average customer lifespan by averaging out the number of years a customer continues purchasing from your company. For our example, let’s say it's 3 years.
  5. Then, calculate lifetime customer value by multiplying customer value ($500) by the average customer lifespan (3). This will give you an estimate of how much revenue you can reasonably expect an average customer to generate for your company over the course of their relationship with you. In our example, the lifetime customer value for Product A customers would come to $1,500.

After doing the same exercise for your other products or services, you may be surprised by what you learn. While Product A may generate more total revenue than Product B, if Product B’s customers have a higher lifetime customer value, it could encourage you to redirect your marketing budget to focus on either acquiring more Product B customers and/or doing a better job retaining Product A customers. And acquiring new vs. retaining current customers often require different strategies and tactics.

If you’d like to talk about your ideal customer or get some help calculating lifetime customer values, give us a call. We have some pretty big nerds on our team who love getting into the data. It’s all in the name of ensuring your marketing dollars are being spent as wisely as possible so that you can achieve your business objectives.

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