As a small business owner, you know that acquiring new customers can be costly and time-consuming. That’s why it’s so important to focus on retaining your existing customers and building long-term relationships with them.
One way to measure the value of your customer relationships is to calculate customer lifetime value (CLV). CLV is the total revenue that a customer is expected to generate throughout their relationship with your business. It considers factors such as the customer’s average purchase value, purchase frequency, and churn rate.
Why is Customer Lifetime Value important for small businesses?
CLV is important for small businesses because it helps you to:
- Identify your most valuable customers
- Allocate your marketing resources more effectively
- Make better decisions about customer retention strategies
- Set realistic revenue goals
- Increase your overall profitability
Knowing your CLV makes also makes it easier to decide how much you are willing to pay in customer acquisition costs.
How to calculate your Customer Lifetime Value
There are a few different ways to calculate CLV, but the simplest formula is:
CLV = Average purchase value * Purchase frequency * Average customer lifespan
Average purchase value is the average amount of money that a customer spends on each purchase. You can calculate this by dividing your total revenue by the number of purchases.
Purchase frequency is the average number of times that a customer makes a purchase from your business in a given period of time. You can calculate this by dividing the number of purchases by the number of active customers in the same period.
Average customer lifespan is the average amount of time that a customer remains active with your business. You can calculate this by dividing the total number of customer days by the number of active customers.
CLV Sample Calculation
Let’s say that you own a coffee shop and your average customer spends $5 per visit. Your customers visit your shop an average of two times per week and remain active customers for an average of six months.
Using the CLV formula, we can calculate that the average CLV for your coffee shop is:
CLV = $5/visit * 2 visits/week * 26 weeks/year = $260
This means that you can expect to generate an average of $260 in revenue from each customer over the course of their relationship with your coffee shop.
By knowing your CLV, you can make better decisions about allocating your resources and improving your overall profitability. For example, you may decide to invest more in customer retention programs or to offer loyalty rewards to encourage customers to visit your shop more often.
Using CLV to Make Smart Business Decisions
Identify and focus on high-value customers. CLV can help small businesses identify and focus on their high-value customers. These are the customers who are most likely to spend more money with the business over the long term. By understanding their high-value customers’ needs and preferences, small businesses can develop marketing and sales strategies to retain and grow this customer segment.
The management of a luxury clothing business can use CLV to identify its high-value customers. These customers might be people who have made multiple purchases over a certain amount of money or who have signed up for the business’s loyalty program. The business could then target these customers with special offers and promotions to encourage them to continue spending with the business.
Allocate marketing and sales resources more efficiently. CLV can also help small businesses allocate their marketing and sales resources more efficiently. By knowing how much revenue each customer is likely to generate over their lifetime, businesses can focus their resources on acquiring and retaining the most valuable customers.
A company selling software might use CLV to allocate its marketing budget to different channels. The business might find that its high-value customers are most likely to come from paid advertising, so it might allocate more of its budget to this channel. The business might also find that its high-value customers are more likely to stay with the business if they receive excellent customer support, so it might allocate more resources to this area.
Make informed decisions about product development and pricing. CLV can also be used to make informed decisions about product development and pricing. By understanding how much value each customer segment is generating, businesses can develop products and services that meet the needs of their most valuable customers and price them accordingly.
A coffee shop owner could use CLV to determine which types of coffee beans to source and which coffee drinks to offer. The business might find that its high-value customers are more likely to buy single-origin coffee beans and specialty coffee drinks, so it might focus on sourcing and offering these products. The business might also find that its high-value customers are willing to pay a premium for high-quality coffee, so it might price its products accordingly.
Set realistic growth goals. CLV can also be used to set realistic growth goals. By understanding the average CLV of their customers, businesses can forecast how much revenue they need to generate to achieve their desired growth targets.
A digital course creator might use CLV to determine how many new students it needs to enroll each month to achieve its growth goals. The business might also use CLV to determine the maximum amount it is willing to spend on marketing and advertising to acquire new students.
Evaluate the success of marketing campaigns. CLV can also be used to evaluate the success of marketing campaigns. By tracking the CLV of customers acquired through different campaigns, businesses can determine which campaigns are most effective at generating high-value customers.
A salon focused on selling skin care products might use CLV to evaluate the success of its social media marketing campaigns. The business might track the CLV of customers who have come from different social media platforms, such as Instagram, Facebook, and TikTok. This information can then be used to optimize social media campaigns and focus on the platforms that are generating the most high-value customers.
How to Increase CLV
There are several things that you can do to increase your customer lifetime value.
- Providing excellent customer service and support. Customers are more likely to continue doing business with a company that provides them with excellent customer service and support. This means being responsive to customer inquiries and resolving any issues quickly and efficiently.
- Offering loyalty programs and rewards. Loyalty programs and rewards can incentivize customers to continue doing business with a company. This can include offering discounts, points, or other rewards for repeat purchases.
- Personalizing the customer experience. Customers appreciate it when businesses take the time to personalize their experience. This can be done by sending personalized emails, recommendations, and offers.
- Upselling and cross-selling relevant products or services. Upselling and cross-selling are effective ways to increase the average order value and CLV. Businesses can do this by offering complementary products or services to customers who are already interested in a particular product or service.
- Building strong relationships with customers. Businesses can build strong relationships with customers by communicating with them regularly and providing them with valuable content. This can be done through social media, email marketing, or other channels.
Know Your Numbers
CLV is an important metric for small businesses to track. By understanding your CLV, you can make better decisions about how to allocate your resources and improve your overall profitability.