As an e-commerce business owner, it is crucial to understand the metrics used to gauge the health of your business. These metrics help you gain insight into your performance and can help you build customized strategies and budgets for the future. Customer Lifetime Value (CLV) is one metric you can’t miss keeping a track of.
Keeping a healthy inflow of customers is important to any business. Both customer acquisition and retention involve large sums of money. Customer Lifetime Value, allows you to assess the worth of each customer you acquire in the long run. It is also used to help analyze how much budget can you allocate for customer acquisition and retention.
What is Customer Lifetime Value?
CLV helps you estimate the revenue that a customer will help you generate during his association with your business. In simple terms, it helps define the value a customer contributes to your business.
More often than not, businesses avoid looking into these metrics, due to the sheer amount of mathematics and calculations involved.
We’ll introduce you to a simple method of calculating CLV and inputs on how it to use it to grow your business.
How to calculate the Customer Lifetime Value?
Instead of dwelling in large confusing formulas, here is a simple approach to calculating the CLV.
In this step-by-step process, you will first have to calculate the following variables. The time frame depends on the stage of your businesses and your budget allocation. For an ease in calculations, we have taken the time period to be set for 365 days (1 year).
The variables are:
- Average Order Value (AOV): The average of how much is money you make in sales with each new order.
Average Order Value (AOV) = Total revenue generated in 365 days/ Total number of orders
- Purchase Frequency (f): Defines the number of times a customer will purchase from you in a year. We have taken the time period for all calculations to be 1 year. You can customize it to suit your needs. This metric helps define customer frequency and gauge whether you have a successful customer retention strategy.
Purchase Frequency (f) = Total number of order in 365 days/ Total number of new customers
- Customer Value (CV): Defines the value addition that the customer contributes in terms of revenue for your business, for a set period of time.
Customer Value (CV) = Average Order Value (AOV) X Purchase Frequency (f)
- Customer’s Average Lifespan (t): This is one the most difficult metrics to gauge. This can be defined as the estimation of the average time a customer continues to transact with you before he decides to switch brands or stops associating with you. A general approximation for a customer’s association with any brand before he switches is 1-3 years.
Using these above variables, you can define the CLV:
Customer Lifetime Value (CLV) = Customer Value (CV) X Customer’s Average Lifespan (t)
Using this formula you can mathematically estimate how long a customer will stay loyal to you.
Additionally, it will also allow you to numerically analyze the worth of a customer who was acquired in terms of revenue generation. It helps to estimate the marketing and budgeting costs associated with retaining a loyal customer.
Though the above formula can be used to give you an estimate, it ignores important variables such as your business’ profit margin and customer variance.
You could try other variants of CLV:
- Customer Lifetime Value Including Margin: This takes into consideration the profit margin. The profit margin is the final amount that reaches you subtracting all other variable costs involved. This is a constant and varies from business to business.
Customer Lifetime Value Including Margin = Average Order Value (AOV) X Purchase Frequency (f) X Profit margin (m)
- Customer Lifetime Value by Segment: This takes into consideration the customer variance. This means that different customers have different needs and spending tendencies. While averages are an easy way to get an overall picture, creating segments help analyze targeted customers and their spends. This metric is calculated using the same above mentioned formulas for different segments. This will help gain a better understanding of specific customers. These segments can be based on location, modes of distributions, select marketing campaigns and more.
Why should businesses calculate Customer Lifetime Value?
CLV helps you numerically analyze your spends and project future spends and growth. It also helps you determine how much money you can spend to acquire new customers based on the revenue you generate.
Additionally, you can evaluate the financial impact on your customers when you rebrand, run special discount campaigns, change your pricing and more.
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