Customer lifetime value tells us how much a customer is worth to a business. While the concept is straightforward, it’s important to understand a few nuances.
Why? Because a new customer can be several times more expensive than retaining an existing one. Understanding and optimizing for CLV helps shift the the focus from short-term transactions to more valuable long-term relationships.
What is Customer Lifetime Value (CLV)?
Customer Lifetime Value (CLV) is an important sales metric.
It measures the total net profit that a business earns from the entirety of its relationship with a customer. It's not just a measure of one purchase, but an estimate of all interactions and transactions over the duration of a business relationship.
Why is Customer Lifetime Value Important?
Understanding and using CLV is crucial for several reasons. The 3 main reasons are…
- Prioritization: By identifying the CLV of customers, segments, and cohorts, businesses can allocate their marketing and support resources more effectively. This yields more high-value customers, often for less spend.
- Profitability: CLV provides a comprehensive view of customer profitability over time, which helps in forecasting and budgeting. Understanding profitability over time can also help create new tactics that increase CLV.
- Strategy: CLV can inform decisions around product development, pricing, customer support, and retention.
Customer Acquisition Cost (CAC) vs Customer Lifetime Value (CLV)
Customer Acquisition Cost (CAC) is the cost a business incurs to acquire a new customer, including all expenses related to marketing and sales. CLV, as mentioned, denotes the projected net profit from that customer throughout their relationship with the business.
To ensure the health and sustainability of a business, it's crucial to maintain a favorable CAC:CLV ratio. One notable exception is the SaaS niche. In SaaS, it is often acceptable to win customers at a loss while fighting for traction.
A healthy CAC:CLV ratio is 1:3, meaning that every dollar spent on customer acquisition earns three dollars over a customer's lifetime. This ratio ensures that the investment in acquiring a customer leads to a positive return over time.
Customer Lifetime Value vs Lifetime Value
While often used interchangeably, there's a subtle difference between CLV and LTV (Lifetime Value).
Customer Lifetime Value (CLV) is specific to a single customer, segment, or cohort. LTV is the total lifetime value for all customers.
The lines between the terms are often blurred, so it is not a mistake to use one instead of the other. That being said, CLV is more specific than LTV.
3 Ways to Increase CLV
Better Customer Support
Resolving issues efficiently and ensuring satisfaction can prolong the duration of a customer's relationship with the company.
Upselling and Cross-Selling
By understanding customer needs and behaviour, businesses can introduce them to higher-tier products or complementary offerings. This not only increases immediate revenue but can also cement a more involved relationship with the customer.
Offering rewards, exclusive deals, or benefits to returning customers encourages repeated business and can lead to higher spending.
Loyalty programs can act as an incentive for customers to choose a particular business over competitors repeatedly.