Familiar with Shark Tank? Of course you are.
Well, I’m sure you’ve seen those awkward moments of silence where the sharks (aka investors) ask a budding entrepreneur about some of their numbers. And, they go blank because they just don’t have an answer. They didn’t have those specific, yet important, numbers on their radar.
So, let me ask you this: do you know the customer lifetime value (CLV) for your small business—restaurant, hair salon, gym, or other low customer lifetime value biz? Customer lifetime what? Yes, I just threw some marketing jargon in your face. But, I wouldn’t be surprised if you just shook your head no in response.
In fact, research has found that just 42% of companies are able to measure their CLV. (And, that doesn’t mean those companies actually put those numbers to good use, either.)
It is, however, the metric that matters. I know you probably get super fired up when you close a one-time, big deal. But, as the CLV proves, it’s not the size of the deal that matters. It’s the duration of the relationship with your customer. After all, it costs five times as much to acquire a new customer than to keep an existing one.
Ultimately, it’s an invaluable metric to determine the ROI of your marketing efforts. All while making calculated decisions about where to put the most effort and money to generate the greatest success.
Take a breath and pause for a moment. If you’re already on edge about not having been calculating the value of your customers and feeling like you’ve been cheating your business of its long-term success, don’t panic.
I’m here to break it all down for you in clear and simple terms—why customer lifetime value matters to small businesses and how to calculate it.
Ready? Let’s not waste any time and jump right into the good stuff…
What The Heck Is Customer Lifetime Value (CLV)?
Also known as LTV or LCV or CLTV… CLV is the amount of net profit your company can expect to generate from a customer’s purchases over the course of your relationship with them (weeks, months, years, etc.). Basically, it hinges on how long, on average, you are able to retain your customers.
The net profit part is important. If two customers both spent $500, but one of the customers required more support (staff hours), the two have very different net profits. Revenue won’t show you that discrepancy, but net profit will.
Depending on your business, this may or may not matter much to you. But, for some, it’ll make or break the legitimacy of the CLV. Got it? Moving on…
In general, your business’s CLV refers to the average value of all of your customers—despite the fact that each individual customer has a unique lifetime value as well as each buyer persona, and so on.
A common example when marketing gurus talk about CLV is Starbucks. While customers spend, on average, about $6 per visit on a cup of joe or their drink of choice, their average lifetime value is close to $14,000. Hot dang.
Now, not everyone in the world is the coffee-every-morning type. Say Joy Holiday only grabs Starbucks during the holidays, compared to Joe Beans who needs a cup (or two, or three) to get through each and every workday.
If Joy’s CLV is roughly $1,500 and Joe’s $19,000, the coffee chain’s marketing team definitely looks to amplify its efforts around the holidays. It’s no wonder you can’t ever miss all those selfies or staged coffee-in-hand photos plastered across social media featuring those infamous red cups once November arrives.
Personally, I’m more of a Joy Holiday when it comes to my coffee drinking habits. Christmas Blend lover right here! But, if we were talking about my lifetime value with Amazon since I began my unhealthy relationship with its amazing 2-day delivery feature… Well, I’ll just keep that number to myself.
How Do I Calculate It?
I’m guessing I might’ve convinced you to start calculating your lifetime value, if you aren’t doing so already. And, if I haven’t, I soon will. Well… after I walk you through the math side of things.
One thing is for sure: this isn’t something that can be worked out on a cocktail napkin. Not to mention, there are many different variations as to how you can calculate your CLV. Just look at this image from Google search. Yikes.
I’m far from being a math guru. If you are… great. But, if just looking at that image made your skin crawl, I’m going to give you a no-frills way to get the job done.
And, note, while there are definitely many tools out there to do the math for you, it’s important you know and understand the concept to successfully weave your CLV calculations into your business strategy.
Before we begin, let's clear the air again… this CLV formula is only for businesses that have customers with a LOW lifetime value.
Think hair salons, gyms, restaurants, and even power washers—those that have the opportunity to bring in a plethora of customers through the door. But, those customers have less value because they ultimately won't be investing a lot of money in the future or coming back often.
If I called out your biz just now, stick around. If not, stay tuned for another blog post coming your way in the near future that'll have just the formula for you and your high lifetime value customer-focused biz.
Okay. Here we go…
To figure your average CLV, you can easily divide the average customer spend per month by the monthly customer churn rate (average % of customers who don’t come back each month).
Here’s what the formula looks like for those visual learners out there:
Now, you're probably wondering: how in the world do I calculate the monthly customer churn rate? It's actually quite simple.
Here's the equation:
Customer Churn Rate:
(# of customers at the beginning of a month — # of customers at the end of a month)
# of customers at the beginning of a month
*Note: You can calculate the churn rate based on any period of time—monthly, quarterly, or annually. Your choice. Do not, however, include any new sales from that period of time in the equation.
So, let's say PJ's Pizzeria, a fictitious company, had 500 customers at the beginning of the month and only 450 customers at the end of the month.
To calculate its churn, it would take [500 minus 450] and divide that number by 500 = 50/500. Thus, PJ's Pizzeria's churn rate is 10%.
Easy right? Now that's taken care of, let’s walk through an example together to calculate the CLV using that same company.
The average spend among customers per month was $35.
And, again, the monthly percent of customers who didn’t come back was 10%.
$35 divided by 10% = $350, PJ’s Pizzeria’s customer lifetime value.
Of course, you always want your CLV to be as high as possible. And, you can increase it in one of two ways. Either customers up their spending or you get more customers to come back, reducing the monthly churn rate.
It should be a no-brainer that you’d want to get more customers to stick around and be loyal to your business. But, even at the largest restaurant chains, many customers don’t return.
Yikes. So, what does that mean for you and your small business? Well, one of your main goals should be to get your customers hooked on your business, making them come back time and time again.
To do just that, never ever stop surprising and delighting new and long-standing customers. Send out a satisfaction survey with an incentive to return. Implement a loyalty program and make it the core of your marketing strategy. Be there when they need you. Make quality a priority. The list goes on and on.
Just don’t lose sight of leading your customers to their end goal—their happily ever after with your business. Because, after all, when you build up a solid squad of loyal customers while reducing your churn rate, you can increase your profitability by 25-125%.
So… Why Does It Matter to My Business and Me?
I’m glad you asked. As I shared with you earlier, you already know acquiring new customers is much more expensive than nurturing the relationships with your current customer base. Also, the probability of selling to an existing customer is 60-70%, while the probability of selling to a new prospect is 5-20%.
Again, why does it matter? Because it helps your business with…
> Budgeting—allows you to determine the maximum allowable acquisition cost for new customers. Using those numbers, you can develop a thoughtful marketing and advertising budget that is related to the profitability of your business. Finally, you have a tool that'll help you spend your hard-earned dollars wisely.
> Marketing and advertising messaging—offers you the opportunity to generate CLVs based on various buyer personas within your business. Therefore, you’re able to segment customers according to your calculations, delivering specific groups different messaging they need and will respond to.
It also helps with your targeting efforts. Your CLV calculations show you how much you spent on acquiring a new customer. If it was worth it, you can dive deeper into their demographics. Then, hone in on the ideal customer profile that delivers the highest profit.
> ROI—provides an accurate measurement of any and all marketing campaign performance, generating a real ROI from your customer acquisition efforts. Generally, the traditional ROI formula isn’t good enough as it measures revenue based on the first transaction alone.
> Retention efforts—helps you focus on keeping loyal customers in your circle while identifying churn or the rate your buyers stop paying for your services. As a result, you’ll know the segment of customers you need to win back, the strategies to implement, and the steps to make them interested again.
Convinced now? I thought so.
You see, in the simplest terms, CLV helps identify how much profit you’re driving with your customers. And, ultimately, it gives you the secret sauce that’ll lead you to developing a solid marketing plan—pointing out which customers you should re-invest in. Thus, optimizing the allocation of your resources for maximum profit.
So, what are you waiting for? The ball is in your court.
You now have the basics you need to get going on measuring the CLV for your business—what it is, how to calculate it, and why it matters. Remember, it’s a powerful tool and important marketing metric (oftentimes referred to as the “golden metric”) you can start leveraging today to identify the marketing campaigns, and even in-store interactions, that are bringing in your very best customers.
And, if you’re looking for help in strengthening your advertising efforts—especially when it comes to the oftentimes-murky waters of Facebook advertising—join AdLab now. It’s your unfair advantage to staying ahead of the game (and never again getting left behind by frequent changes and updates).
Are you already measuring the CLV for your business? If so, in what ways have you found it helpful when it comes to furthering your success? Let us know in the comments section below. We’d love to hear from you.