Why Companies need to calculate Customer Lifetime Value?
In previous article, we discussed how startups can use ARPU to add value to SaaS application?. We concluded that even that ARPPU (Average Revenue Per Paying User) grows, but Paying Share falls, this will lead to a reduction in your income - the profit from paying will not be able to compensate for the reduction in their number. This metric helps you evaluate and predict your income. Today, we will discuss why they need to calculate Customer Lifetime Value (CLV or LTV)? and how they can use it for their benefit?
Customer lifetime value (CLV or LTV) - the sum of all the profit that the customer has brought or will bring to the company for the entire time of cooperation with her. It allows you to determine how much your customers spend, how often and how long they buy from you.
This metric refers to a long-term customer service strategy.
How to calculate customer lifetime value
Let's look at several calculation methods:
LTV = [Profit] - [CPC]
where CPC is the cost per customer acquisition.
We will not consider the calculation of the cost of one client (lead). For many, this is obvious, and modern analytical tools allow you to do this automatically for each channel of attraction, and choose the most effective.
Option # 2
We take the average values for all indicators.
LTV = [Average bill] x [Number of sales] x [Period of cooperation]
($25 per sale) x (12 sales per year) x (2 years) = $600 .
LTV goal: Optimization of the marketing budget for customer acquisition. Based on the obtained values, we can increase the costs of attraction by linking them to all profits from the client, and not to profit from the first sale.
As you might have guessed, LTV calculation is based on internal analytics of your company, and not data common to the market.
Customer retention rate
Another important indicator is the customer retention rate (CRR). It supplements the data on the customer’s lifetime value and allows you to analyze the effectiveness of the selected marketing strategy.
Simplified formula for calculating customer retention rates:
CRR = ((E * N) / S) * 100
E - the number of customers at the end of the period;
N - the number of new customers attracted for the period;
S - the number of customers at the beginning of the period.
Example: Take a specific customer segment. At the beginning of the year there were 450 customers [ S ]. Over the course of the year, it took 100, but we attracted 150 new [ N ]. Those. At the end of the year we have 500 customers [ E ]. Based on the above formula, we obtain:
((500-150) / 450) * 100 = 77.7%
It will also be useful to calculate the coefficient of outflow (turnover) of customers (Churn rate). When a customer stops buying from you.
(10 clients left / 160 clients) * 100 = 6.25%
Why do companies need LTV?
The calculation of the customer’s lifetime value shows which customers are more or less valuable in monetary terms.
When developing a strategy for attracting customers, we can calculate the cost of attracting one customer based not on the profit from one (usually the first) sale, but on the profit from all sales to the client. Thus, we can increase the cost of attraction, which will pay off in the long run.
How to increase customer lifetime value?
A lot of factors influence the increase of this indicator, but let's look at some of them:
For example, you can determine the LTV for different segments of your customers and, based on the data received, increase or decrease the cost of attracting specific groups of customers. Therefore, to attract segments of more loyal customers and increase revenue from each client and the total revenue of the company.
Constantly analyze the problems and needs of your customers. Based on this analysis, create and offer new products and services. Even if they are not typical for you at this stage of your company’s development. Be a "single point of entry" for customers to solve their daily problems.