What’s Customer Lifetime Value and why is it important?

Have you noticed how some companies are all over you when you’re thinking about buying from them?

Then when you’ve made your decision they disappear… If you have a problem 12 months down the line it’s as though their customer service team has been kidnapped.

In many industries customers don’t change supplier very often. It’s just too much trouble. Savvy businesses in these sectors know that bombarding you with love and attention in the early days could turn you into a client for life. They’ve figured out customer lifetime value. In this post, we’re exploring what customer lifetime value means, how to calculate it for your own business, and why you should care.

In what industries is customer lifetime value important?

You can quickly come up with a list of industries that are desperate to help when you’re a potential customer.

For example, lots of software companies are like this. If you’re in business you’ll no doubt be bombarded by providers of CRM systems and accounting apps like Xero or Quickbooks.

Not only that, but they’ll offer healthy discounts for new customers. At the time of writing Quickbooks are giving a very generous 75% discount for four months.

Most subscription businesses work this way too. Think of home-delivery meal kits like Gousto or HelloFresh. Google these companies and you’re bombarded with discount offers all trying to out-shout each other.

What is customer lifetime value?

Customer lifetime value is exactly what it says on the tin. It’s the amount of money a business will typically make from a new customer over their lifetime with you.

You can decide how you want to measure it; whether that’s sales or profit, or whether you measure big corporate clients differently from SMEs and charities.

But ultimately it comes down to the same calculation: take the number of years you can usually expect to retain a client and multiply by your average customer spend. That’s your CLV.

Why is customer lifetime value important?

CLV is a critical part of calculating customer profitability. Deduct your cost to serve (including product cost) and acquisition cost from CLV and you’re left with customer profitability.

For example, if you’re one of those meal kit companies then your ongoing cost to serve has to include the costs of ingredients and delivery. That’s why it’s not a cheap option.

Yet if you run a software business your ongoing cost is virtually nothing. Once you’ve covered the cost of acquisition everything else is profit.

That’s why businesses like this are so happy to splurge on introductory discounts and free service calls. The cost of your “onboarding” is peanuts compared to what they’ll make from you in the next few years.

Cash is king

One thing to watch out for if heavy initial discounts is part of your sales strategy is the impact on your cashflow.

If you can look forward to ten years of sales from a new customer it could be a sound investment to spend heavily on customer acquisition.

Your business plan five years from now will show a healthy customer base, with most turning you a happy profit.

But imagine if your typical customer wasn’t profitable until year three. You’re boosting sales by bringing in new customers, yet the more you find, the more you lose.

This is the model that many of the world’s biggest tech companies have used. Businesses like Amazon, Uber and Facebook lost money for years.

They got through this because they had massive outside investment. Shareholders who were happy to sit it out, believing they would get their return in the long run. Most small businesses don’t have this luxury.

Why does customer lifetime value matter in my business?

If you were to work through scenarios calculating CLV you’d likely reach one conclusion: Keeping customers for longer is crucial.

Businesses often get really excited about chasing new prospects and acquiring new lead generation tools.

Yet a lot of research suggests focusing on retaining clients pays back faster than constantly chasing new ones. It’s more efficient (you already have client relationships) and it’s more predictable (you already have trust. And an account number).

Sure, you can improve your CLV ratio by cutting back on acquisition cost, but this should only be about effectiveness, not about reducing marketing spend.

The hidden multiplier in customer lifetime value

Once you start driving CLV through keeping customers for longer you’re likely to build up a network of loyal customers.

This of course triggers the hidden multiplier: longstanding, loyal customers who are more likely to recommend you to others.

Your sales process for referrals is almost certainly going to be quicker and cheaper than your normal new lead generation marketing campaign. More often than not, when someone has been “told” to work with you they will!

You could find that your initial acquisition cost for meeting customer A leads into a free referral to customer B. And on it goes.

So the main takeaway from improving customer lifetime value? Look after your customers and they will look after you.

You may also be interested in: “Are you easy to buy from?“