Calculating Customer Lifetime ValueAssociation of Business Training
August 21, 2012 — 1,091 views
When it comes to marketing, it can sometimes be difficult to define exactly how much a customer or target audience is worth. How can you put a solid number on something as abstract as customer retention and loyalty? This is the constant struggle that marketing executives face every single day.
However, there is a way to determine the net worth of clients. The term "customer lifetime value" (CLV) is an index that forecasts the estimated total profit that a single customer or client group will bring over the course of a business relationship.
The mathematics behind customer lifetime value can be extraordinarily complex and confusing, so check out the following tips that outline the process in layman's terms.
The first step toward determining CLV is identifying the variables associated with your equation. For example, imagine a restaurant that is trying to figure out the value of a daily coffee customer. The establishment needs to find the "s" variable, or the average of how much money customers spends per visit, usually sampling five patrons. Then, the "r" value must be calculated, which is the average number of visits to the restaurant per week (again, normally across five customers). Finally, the "a" variable equation "A = S x R" can be used to find the average customer value per week.
The aforementioned variables will then be compared to numbers called "constants" - facts and figures that will not change on a weekly basis. The following constants are commonly used in CLV equations.
T - refers to the "Average Customer Lifespan"
R - short for "Customer Retention Rate"
P - stands for "Profit Margin per Customer"
I - called "Rate of Discount"
M - is read as "Average Gross Margin per Customer Lifespan"
Company metrics determine the value of these numbers, which are dependent on the business as a whole rather than the individual consumer.
Calculating a simple CLV
Major companies typically use a bunch of different equations to determine CLV in a currency amount, and then average the results together to come up with a single number. For example, here are two common sample equations.
1.) 52(A) x T
2.) T(52 x S x C x P)
The final cash value of these formulas can be added up and then divided in half to determine a sample CLV over the customer's lifetime.