Your Guide to Lifetime Value, Part One: What is Customer Lifetime Value?

Roberto Mejia
by Roberto Mejia on December 21, 2012 in Business
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How much is one customer worth? 

That question is highly important to marketers, who are in the business of attracting customers and driving sales. The overall value of a customer determines the amount you can spend on acquiring or keeping that customer. And since the value of a customer to your company is influenced by all aspects of your business operations, from controlling expenses to customer service, it provides a useful target for continuous improvement.

The question is, what is the best way to calculate the lifetime value of a customer? It starts with an understanding of the customer's spending habits. How frequently does the customer make a purchase? How much does he spend on average within a certain time period?  

What is the Customer Lifetime Value?

Technically speaking, the formula for determining a customer's lifetime value is: 

Average value of sale  x  number of repeat transactions  x  average retention time 

In other words, the customer lifetime value metric is the net present value of all current and future profits that will come from sales to a particular customer. Since the value of the company itself is the net present value of all future profits from all customers, this lifetime value number actually determines how much your company is worth; its value is the combined customer lifetime value from all present and future customers. 

In slightly simpler terms, a repeat customer who spends a certain amount within a certain timeframe is worth spending a certain amount of money and resources to keep. As long as the money spent to acquire and retain the customer is less than his lifetime value, the customer will generate a profit for your company.

Because customer lifetime value is such an overarching measure of business success, it is the most important metric for top-level marketing managers. 

How to find the Customer Lifetime Value

While there are advanced tools to help estimate lifetime customer value, it can be calculated without too much difficulty.

If you have an established company, the best way to calculate customer lifetime value is to look at what each customer has been worth to you in the past--their historical lifetime value, in other words. You can use that history to help project what they will do in the future, or what similar people will do if you attract them as new customers. 

Besides projecting sales, the lifetime value metric requires you to project the costs and marketing expenditures needed to attract and retain each customer. This data becomes useful when you’re allocating your budget for incentive programs, promotions and other marketing expenditures. Since much of this is under your control, you can use these calculations to develop your online marketing strategies and determine the best course of action to take. For example, offering free memberships, online coupons or promotional discounts can be a smart expense if they entice a new customer to spend money on repeat purchases or pay upfront for a year’s worth of products and/or services.

We'll dive deeper into the ways you can use this metric in the second portion of our two-part post on customer lifetime value and its benefits. In the meantime, start caluclating your business' lifetime value figures, and get ready to put those numbers to good use.

Roberto Mejia

Roberto Mejia

While specializing in web development and inbound marketing, Roberto Mejia prides himself in always learning and improving as much as possible.