Why is Customer Lifetime Value Important?
Customer Lifetime Value is the total revenue your business can expect from a single customer. In my opinion, it is one of the most important metrics to measure at any growing company. Research has shown us that it costs 6 – 7 times as much to attract a new customer as it does to keep an existing customer. Once you understand the lifetime value of a customer you will understand the importance of ensuring that every customer journey ends with a WOW!
Customer Acquisition Cost
First, let’s take a look at the cost of acquiring a new customer or customer acquisition cost.
Today, digital marketing allows us to reach more of the right people at the right time in their customer journey. People learn to know, like and trust you based on how authentic you are on social media, how useful the information is that you provide on your website, and how many people recommend your services. Rather than spending time cold-calling, you are spending money on things like email marketing platforms and Facebook ads. So the question becomes, how much money do you have to spend to generate one sale or obtain one customer? This information is readily available through analytics and insights that are available on pretty much any digital marketing platform you use.
By measuring customer lifetime value in relation to the cost of customer acquisition, businesses can measure how long it takes to recoup the investment required to earn a new customer, namely sales and marketing. The metric informs business owners how much revenue they can expect one customer to generate over the course of their entire relationship with the business. This is something sales and marketing teams can directly influence.
Calculating Customer Lifetime Value
- Calculate average purchase value by dividing your company’s total revenue in a time period (usually one year) by the number of purchases over the course of that same time period.
Total Revenue / # of Purchases = Average Purchase Value
- Calculate the average purchase frequency rate by dividing the number of purchases over the course of the time period by the number of unique customers who made purchases during that time period.
Average Purchase Value / # of Unique Customers = Average Purchase Frequency
- Calculate average customer lifespan by averaging out the number of years a customer continues purchasing from your company.
How many years does a customer remain loyal to you and/or your brand?
- Then, calculate LTV by multiplying average purchase value by average purchase frequency and then by the average customer lifespan. 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.
(Average Purchase Value x Average Purchase Frequency) x Customer Lifespan = Customer Lifetime Value
Starbuck’s Customer Lifetime Value Example
Starbucks estimates that customers spend, on average, $5.90 each time they visit a Starbuck’s location.
They then estimate that customers visit a Starbuck’s location an average of 4.2 times per week.
By multiplying $5.90 by 4.2 we find that the average customer value per week is $24.30
They estimate that a customer will remain loyal to the Starbuck’s brand for 20 years, on average.
Customer Lifetime Value = ($24.30 x 52 weeks) x 20 = $25,272
I encourage you to take some time to calculate the lifetime value of your customer. Compare this to the cost of acquiring one new customer and you decide. Should you invest in ways to ensure your customer experience is exceptional? Or, should you keep spending your money trying to acquire new customers?
Our post on the Customer Experience will help you with some strategies on keeping your existing customers so they come back to you time and time again.