Ever wonder what kind of impact one person has on your company? Can one person really mean that much in the grand scheme of things? Philosophy majors finally have something in common with the average CEO: both want to know the bottom line of one versus many. Granted, the philosophy major is a little more concerned with the history of humanity versus the CEO who just wants to know quarterly revenue metrics, but still, it’s nice to see them agree on something.

While the philosophy major may have a harder time making the calculation, businesses have decided on a metric to shed some light on the revenue impact an individual has on a company: Customer Lifetime Value (CLV). So what is it and how do you actually go about calculating it? Scroll down and we’ll answer your questions.

What is Customer Lifetime Value?

CLV is one of the more important customer metrics that demonstrates the impact of a customer on the business at large. It essentially just represents the total amount of money a customer is expected to spend on your product during their lifetime as a customer of your company. The longer someone stays with and pays a company, the higher the CLV. Properly understanding and utilizing this metric gives insight into how your company can acquire and retain valuable customers to grow the business. With that in mind, let’s jump into how you can calculate CLV.

How do you Calculate CLV?

At its bare bones, CLV is actually a relatively straightforward calculation.

CLV = Average Purchase Price x Average Number of Purchases (per year) x Average Length of Customer Relationship (in years)

So if one person buys your product for $100 with an annual subscription and they stay with the company for three years, their individual CLV would be $300 ($100 x 1 x 3).

Keep in mind that you may need to tweak this metric to fit your company. Depending on how many touch points your customers have over their lifecycle with you, calculating the average CLV can either remain a straightforward process or it can become a bit more complex. Not everyone does annual subscriptions or measures customers in terms of years, particularly younger companies that haven’t been around as long. So while the typical process is CLV in terms of years, you can adapt it to be for months or weeks if that works better for your product.

Larger companies working with more than one product, that have a range of different prices, and a high number of customers who churn at different rates are going to require the team to spend more time and care in determining the CLV of importance to them. It may make more sense in cases with multiple products, to calculate CLV of each product in order to compare the revenue impact between product, rather than take a company average and skew perceptions.

Why is CLV important?

Ok, so now you can calculate CLV for your company, but why is this important? At a macro level, CLV helps you understand which customers are actually paying you the most for your product. People don’t always love talking about it, but not all customers are equal. As a business, it’s important to understand which segments of the customer population are more likely to purchase your product, or even which segments are more likely to be receptive to upsell opportunities.

Understanding CLV is also important when considering usage and retention rates. There are a number of factors that could be influencing the value of a customer: contract values, churn rates, engagement metrics, satisfaction scores, etc. As you dig into understanding valuation, you may have to decide if more money should be spent on marketing or if there’s more value in adding more people to customer support or customer success teams. Here are a few key questions that understanding CLV can help answer:

  • How much can we spend on sales and marketing for customer acquisition?
  • Who are our most valuable customer demographics and how can we better target similar companies in the future?
  • How much should we spend on customer success to keep an existing customer?

The other side of the same coin is Customer Acquisition Cost (CAC): the total cost of sales and marketing efforts required to acquire a new customer. For SaaS companies, this could also include the cost of custom integrations for a new customer. The idea is that CLV and CAC act as a bit of a balance for each other. Comparing CLV to CAC measures how long it takes a company to recoup its initial investment required for obtaining a new customer. You want to have a higher CLV to balance out the CAC; it’s how companies make key financial decisions and stay afloat in the long run.

Some companies will calculate the CAC and just use it as a comparison ratio to understand how much higher CLV is than CAC. For instance, if your average CLV is $3,000 and your average CAC is $1500, you can tell that your company is making more money than they’re losing to obtain new customers. The ratio could be better, but you’re not immediately running up a deficit.

However, if your average CLV is $3,000 and your average CAC is $3,200, there’s an obvious problem. Your company is spending more money trying to attract new customers than you’re getting back in revenue. This would be a good time to look at churn rates and determine if a high number of customers are cancelling or if marketing should look to cut campaigns that aren’t making returns. Likely there will be some combination of factors that need to be addressed.

Other companies will actually go ahead and subtract the CAC from the CLV to have a minimum base for lifetime value. In general, the ratio is a better measure for overall company success as it demonstrate a quick comparison between efforts to acquire and efforts to maintain customers. Whereas subtracting CAC from CLV is better used when trying to weigh the financial benefit of adding one particular customer. In that case you can take that individual accounts estimated CLV and subtract the known average CAC to help determine if the deal is as promising as a sales manager might try to imply.

How to Improve CLV

In reality, you don’t need to have the most complex calculation for CLV to provide value and insight to the company. The main priority is understanding touch points throughout the customer lifecycle that can drive the customer relationship forward and increase loyalty.

Manage Customer Relationships

Customer support and customer success teams have a direct influence on customer perceptions of a company throughout a customer’s journey. When looking at retention rates, customer support and customer success teams are your company’s main drivers of loyalty. They’re the one on the front lines, solving key problems and empathizing with customers to ensure they feel valued and happy with your product, rather than frustrated and more likely to churn. If support teams are noticing customers having a specific problem with onboarding, then it’s important for them to communicate that issue to customer success teams who can work on being more proactive with their communications to customers. The closer customers feel to your team, the easier it is to manage their expectations.

Close the Loop

Another way to improve CLV is actually to close the loop with unhappy customers who may be at risk of churning. For instance, a success team may notice low customer satisfaction scores (CSAT), which indicates how happy or unhappy customers are with your product. Because CSAT is a targeted metrics, they can figure out which parts of the product customers are satisfied or unsatisfied with. From there it’s easy to make any necessary adjustments to these specific areas and then let those customer know you’ve taken their feedback into consideration and have just released the updates. Happy customers are more likely to be loyal customers, so the more you can let customer know you hear them and care about their needs, the more likely they are to stick around while you make adjustments for them.

Target Key Customers

CLV gives you insights into which segments of your customers are the highest paying and which customers have the longest lasting relationship with your company. While you want customers to be both high paying and long lasting, that’s not always the case. But by understanding where different customer fall on demographics, you can better target key customers for upsell opportunities. If you notice a specific industry tends to have a higher contract value, then maybe it’s time for the sales team to spend more time prospecting that industry. The goal is to understand where different segments of the customer populations stack against each other and how to get the most value out of each of them.

Conclusion

Customer Lifetime Value is an important metric for a company to track, especially startups where every customer can make or break the company. CLV gives you insights into key business decisions and where customers deliver the most revenue to your business. The better you understand your customers and their relationship to your product, the better you can tailor their experience to create long lasting relationships.