The value of your customer over their purchasing lifetime is a very important aspect to consider.
It can help you determine how much to budget for your marketing and effectively what customer retaining offers you can afford over the longer period.
Learn more about understanding the lifetime customer value here.
What Is the Lifetime Customer Value?
The Lifetime Customer Value (LCV) is essentially the total amount of net profit which a customer will generate for a business. The lifetime of a customer can be anything from a few days to a period spread over many years.
The equation also considers costs, including the marketing costs, to acquire the customer (known as Customer Acquisition Cost or CAC).
For instance, if a product costs $20 to make and is sold for $50, then the profit for each one (excluding the customer acquisition cost) would be $30. So if a customer bought a product once from you and then never returned, their LCV would be $30. However, if they bought one every month for 2 years, their LCV would $720.
But the LCV isn’t about the value of just one customer. Instead, you should think of the value as a general view of all your customers, their average spend, costs and acquisition costs.
Calculating the Lifetime Customer Value
The LCV is quite simple to calculate: you take the amount of revenue generated, minus the costs (including marketing) and divide by the number of different customers you have. This might be particularly difficult if you cannot determine the number of customers you have buying products in your business but if you have customer references this can be fairly simple.
The number which you come to is the Lifetime Customer Value.
An example of this would be a company that has sales of $100,000 and costs of $20,000 for 500 customers. The LCV would be (100,000 – 20,000) / 500 = $160.
Because this value represents 500 customers it doesn’t specifically say what each one actually spent with the business, e.g. a small number could have spent over $1000 and a larger proportion under $10.
According to Pareto’s Law, around 80% of your income will come from about 20% of your customers. Therefore it is conceivable that $80,000 was generated by 100 customers. Yet this is not what the LCV is designed to test.
With the LCV it is important to consider the relationship over the longer period between you and the customer.
Why Do You Use the Lifetime Customer Value?
The LCV can be used to help determine your marketing budget. If you know how much it costs to sell and produce a product, you can determine how much you need to spend to acquire customers. This can be difficult, however. Not every individual you are going to interact with is going to purchase a product and therefore the cost for their interaction will have to be absorbed into profits from other customers.
The Customer Acquisition Cost is calculated by the total amount spent divided by the number of new customers generated. Therefore if you spend $10,000 on marketing and acquired 500 customers, your CAC would be $20.
This is great when considering new ways of marketing to determine whether or not they will be productive. For example, if you want to start a paid search marketing campaign where each click would cost $2, and you estimate that 2% of those who click through will become customers; you calculate the costs per customer generation.
2 / 0.02 = $100
This would be your CAC. In comparison to the previous example, this is rather high.
How do You Increase a Lifetime Customer Value?
The key to making a business successful is to increase the LCV. To do this there are three options:
1. Increase the revenue generated by each customer over their lifetime.
2. Decrease the cost of producing the product.
3. Decrease the Customer Acquisition Cost.
Option 2 is all about getting the most value out of your production. This includes buying your supplies for the best value and optimising your production so more is made in the same amount of time.
Option 3 is about streamlining and increasing the effectiveness of your sales and marketing. Part of this could include optimising your website so your call to actions are more effective and your copy is more compelling on paid search, email and social media campaigns. Another thing you can do is to ensure you are targeting the best keywords on your paid search and search engine marketing. In terms of the former, this can reduce your bid price. Review and optimise your sales process as well.
Option 1 is the really important factor when it comes to the LCV. Generally speaking it is less costly to continue to sell to an existing customer than it is to acquire a new customer. Therefore, having a customer purchase more from you is one way to increase the LCV.
This can be done through effective up-selling. You can do this either at the first chance you have (often at the transaction screen) or at a later date with email marketing or further communications with your customers.
Another method is to ensure that you are continuously delighting your customers with excellent products or customer service. Customers are more likely to return to your brand if you make them feel special and they know your product works well.
The Final Word
The Lifetime Customer Value is an important aspect to consider in your marketing. Working out the profit of each customer over a longer period can help you determine the marketing budget for your business. This can then help you create efficient marketing campaigns to draw in customers at the best prices.
The LCV can also support you in realising the value of each customer, even if they make small purchases regularly over a longer period.
- Work out the cost of acquiring a customer (CAC).
- Work out the Lifetime Customer Value (LVC).
- Work out how you can increase the amount of money your current customers spend.