How To Calculate Customer Lifetime Value
Customer Lifetime Value
Understanding the lifetime value of your customer is extremely important. This metric will tell you the potential profit you can expect from individual customer accounts. In order to calculate your customer’s lifetime value, you’ll want to start with a few basic calculations:
Average Purchase Price: Total company revenue for the year divided by total number of purchases that year
Frequency of Purchase: Total number of purchases for the year divided by the number of customer accounts that year
Customer Lifespan: Average amount of time each customer will continue to purchase from your company
Customer Value: Average purchase price multiplied by the frequency of purchase
You will also want to incorporate costs associated to better understand the true profit potential for each customer. Start by determining your Customer Acquisition Cost and any additional Fixed Costs for each customer account.
Customer Acquisition Cost (CAC): Total amount spent acquiring customers for the year (typically your marketing expenses), divided by the number of customers acquired that year
Fixed Costs: Fixed expenses associated with each customer account
To simplify these calculations, we will work through a few examples:
Example 1(a):
In this scenario, your customer often makes one purchase. That is why both frequency and customer lifespan should be set to 1 (If either lifespan or frequency changes, adjustments will need to be made – see example 1b).
Calculated Customer Values
Average Purchase Price: $25,000
Frequency of purchase: 1
Lifespan in years: 1
Customer Value :$25,000
Variable Costs to take into account:
Customer Acquisition Cost: $1,500
Fixed Cost (per customer): $21,500
Calculate your Customer Lifetime Value:
$25,000 (purchase price) x 1 (frequency) x 1 (lifespan) = $25,000
$25,000 – $1,500 (CAC) – $21,500 (fixed costs) = $2,000
Customer Lifetime Value = $2,000
Example 1(b)
In this scenario, you started spending more on the acquisition of a customer and found that your new customers will make about two purchases over the lifespan of one year.
Calculated Customer Values
Average Purchase Price: $25,000
Frequency of purchase: 2
Lifespan in years: 1
Customer Value: $50,000
Variable Costs to take into account:
Customer Acquisition Cost: $5,000
Fixed Cost (per customer): $21,500
Calculate your Customer Lifetime Value:
$25,000 (purchase price) x 2 (frequency) x 1 (lifespan) = $50,000
$50,000 – $5,000 (CAC) – $21,500 (fixed costs) = $23,500
Customer Lifetime Value = $23,500
Example 2
In this scenario, customers generally purchase three times during the first year and are generally no longer customers after that first year.
Calculated Customer Values
Average Purchase Price: $100
Frequency of purchase: 3
Lifespan in years: 1
Customer Value: $300
Variable Costs to take into account:
Customer Acquisition Cost: $10
Fixed Cost (per customer): $30
Calculate your Customer Lifetime Value:
$100 (purchase price) x 3 (frequency) x 1 (lifespan) = $300
$300 – $10 (CAC) – $30 (fixed costs) = $260
Customer Lifetime Value = $260
You’ve Calculated the Lifetime Value of Your Customer…Now What?
Now that you understand the basic calculations to determine your Customer Lifetime Value, here are a few things you can do with this information:
- Understand how much each customer is worth to your business (financially)
- Determine an acceptable acquisition cost
- Evaluate opportunities of products/services you can add to help increase customer frequency and/or lifespan
- Utilize this baseline of metrics to value your product offerings and identify strengths and opportunities for growth
- Isolate data into customer groups (product, location, job type/scale of service, etc.) to evaluate the value of each customer group and help guide areas of opportunity that already exist within your company
As you can see, Customer Lifetime Value is an extremely important key performance indicator and should not be overlooked. Especially when evaluating and determining your acquisition costs. Maximize your profit opportunities by using your data and customer values as a guide and foundation of future decisions.
