How to calculate customer lifespan and lifetime value

For your business to be successful you need to know a few things about your customers.

  • Are your customers loyal to you?
  • How long are they going to stick around?
  • Can you justify your cost of acquiring every new customer or do you need to focus on retaining them for longer?

These might seem like tough questions at first, but this guide will go through exactly what it takes to measure your customer’s lifespan and whether you need to relook at your customer engagement strategy to make it work.

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Why are customer lifespan metrics important?

Understanding your customer’s lifespan is the first step in determining their worth to your business. It can cost five times more to acquire a new customer than to retain an existing one. These are costs worth saving, and are critical to business success.

Knowing how to calculate customer lifespan will also help you:

  • Understand how to optimise the value of an existing customer base
  • Maximise on brand loyalty
  • Prioritise sales, marketing and advertising budgets accordingly
  • Keep your costs of acquisition low
  • Segment customers according to their lifespan metric scores and identify areas for improvement
  • Understand how much revenue is generated from which customers, and who is profitable.

To make the most of customer lifespan metrics, you need to know how to accurately calculate them.

Calculating your customer lifetime value (CLV)

Your CLV will tell you what you can expect to earn from a single customer over the lifespan of their relationship with your business. There exist multiple methods for calculating your business’ CLV, and they could be based on historical data or you can calculate using forecasted numbers. If most of your transactions are based on bulk purchases or subscription plans, using predictive data will make more sense. If you initiate new transactions for every customer, then use the data you already have.

It might sound complicated at first, but we have broken down the steps for calculating CLV:

1.     Average Order Value (AOV)

This is your total revenue over a period of time divided by the total number of purchases made by your customers. Your time period is usually one year, but you can adapt it according to your industry and needs as long as it is a good reflection of your customer purchase behaviour.

AOV = Total revenue / Number of orders

It is important to remember that this number does not represent your customer as a whole. It is an average and could mean that some customers spend more than others or that some months of the year are busier than the rest.

2.     Purchase Frequency Rate (PFR)

Now that you know your customer’s average spend, you need to find out how often this is. Take the total purchase in your time period and divide it by the number of unique customers.

PFR = Number of orders / Unique customers

This is an important metric on its own as well. Increasing the average PFR can grow your revenue and this number tells you how frequently your customers are making a purchase and whether or not they are returning as loyal customers.

3.     Customer Value (CV)

Now before we get to the customer’s lifetime value we stop to find the customer’s value. This metric tells you how much revenue an average customer brings to your company in your specified time period, and not their lifetime. Multiply the average order value with the purchase frequency we found in the last two steps.

CV = AOV x PFR

 

Your CV tells you how much one customer is worth to you on average. Remember that every customer’s value goes beyond just this metric. If they are loyal to your business they will come back for more, recommend you to their network and bring you more business.

4.     Average Customer Lifespan (ACL)

This is the final piece of the equation and is usually the hardest to master. This metric provides the average period of time a customer remains your customer. You’re trying to predict the future, so this is where things start to get tricky. The customer’s lifespan starts from when they first make a purchase up until their last transaction with your business.

Calculate your ACL by averaging the number of years a customer continues to be your patron. You can start by adding all your customer’s lifespans and then dividing that by the number of customers.

ACL = Sum of customer lifespans / Number of customers

 

An easier and quicker way to calculate your ACL is if you know your churn rate, and divide 1 by it. Your churn rate tells you how many customers stop doing business with you after their first purchase.

ACL = 1 / Churn rate (customers at the start of the time period minus customers you’re left with)

 

The final step: How to calculate customer lifespan (CLV)

Now that you’ve got all the variables you need, you can piece them together to calculate your CLV. Multiply your average customer value by the average customer lifetime.

CLV = CV x ACL

Customer Lifetime Value = Customer Value x Average Customer Lifespan

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This result will help you determine how much revenue you can expect from each customer as long as they are patrons to your business, that is, for the duration of their customer lifespan.

Let’s put this into context.

If your CV is £300 a year, and your average customer lifetime is 3 years, then your CLV is £900. That means you need to spend less than £900 per customer to make any money, or at least not lose any. This includes marketing, sales, gifts and any other expenses that go into acquiring a customer.

Ways to improve your customer lifetime value (CLV)

Now that you know how to calculate customer lifespan, it’s time to put it into practice and cultivate it so your business can benefit from this metric.

Upsell

A customer is already at the brink of going through with a transaction. Upsell them something that would interest them to spend more, while keeping your customer acquisition cost the same.

Focus on satisfaction

Your customers’ happiness is the ultimate deciding factor on whether or not they will continue being a patron of your business. 96% of customers say that customer service can affect their loyalty to a brand. Communicate with your customers in a way that ensures them that you care and ask them for feedback regularly to find areas to improve on.

Discounts and offers

Everyone loves getting a bargain, and even more people appreciate a freebie. Create coupon codes that make your customer feel special, but also are still within your profit margins. Send out deals during off-peak times to encourage customers to shop during periods they would have otherwise not considered.

Start a loyalty program

Incentivise repeat purchases to encourage brand loyalty, or think of starting a brand referral scheme where loyal patrons can earn points for every successful new customer they bring in. Loyalty rewards can be in the form of free gifts or an additional discount for every tenth purchase with your company.

Keep in touch

Out of sight is out of mind, so make it a point to reach out to your customers regularly. Emails, SMS reminders, social media content and phone calls to tell them about new product launches or offers will keep you fresh in their mind. However, be careful not to harass or bombard your customers, and keep all communications relevant to their preferences. There’s no point emailing them six times about your new product if they’ve already bought it.

Retention

The longer a customer stays with your brand, the better your CLV. Identify your most valuable customers and nurture them. Re-engage them with personalised service and special treatment.

No matter what customer retention methods you choose to employ, ensure that you listen to customer feedback carefully. Send out surveys and ask customers to leave reviews about your business and services. This shows them that you value their opinion, and you will also gain insights on what is working and what you can improve on for the future. Customer lifespan metrics is a long-term project and can take some time to master.

Using customer lifespan metrics for your business

To make the best use of the above metrics, it is important that you make it part of your company culture and routine right away. The longer you wait, the longer you’re in the dark about your customers’ behaviour and trends. You put in a lot of effort to gain new customers in the first place, it’s time to leverage these lifespan metrics to your advantage. Ultimately, customer experience and customer satisfaction should be at the forefront of your business, and your customer lifespan metrics should dictate how this is done.

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