The true value of a customer is not just the size of the deal. Instead, it should be calculated with other (more important) factors such as how long they are likely to remain your customer.
Researchers estimate that today it costs five times as much to acquire a new customer than it does to retain a current one. That’s significant not only because it demonstrates the importance of customer satisfaction and customer retention, but also because it shows us that we may need to reevaluate the way we calculate the value of our customers.
CLV is even more useful when you can compare it to your cost of customer acquisition cost (CAC) to get your compass quotient (CQ) – we’ll save these topics for another blog post, so don’t panic! For now, let’s dive into CLV.
What is Customer Lifetime Value?
Customer lifetime value is the total amount of revenue that you will receive over the course of your relationship with a specific customer. It hinges on how long, on average, you are able to keep customers.
CLV is the key to figuring out what you’re actually gaining from each customer. If you’re great at getting deals to close and you’re making all of your monthly revenue goals, that’s fantastic. But if you’re having trouble retaining those customers that you worked so hard to get, you’re likely making much less revenue from each customer than you potentially could. The amount of money you’re truly getting out those deals is small, even if there are a lot of them. And depending on your business model, you might not see net profit on a customer until you’ve had them for a cycle or two.
How do you calculate CLV?
Start with three questions that every B2B marketing organization should be able to answer (or at least know where to find the answer):
- What is the average sales value of your first transaction with a customer?
- How much do you typically make per year from a customer after the first purchase – including cross-sell and upsell revenue (if relevant)?
- How long does a typical customer continue to do business with you? (The answer, ideally, will be in years – not months or weeks.)
For example, a typical first sale of $20,000, a typical ongoing annual value of $5,000 and a typical customer lifespan of five years (or 5 * $5,000), yields a CLV of $45,000.
Caveat: There are almost as many ways to figure CLV as there are stars in the sky. Depending on your business model, your finance department could factor in overhead costs, marketing and sales costs, cost of goods, and so on. And some people factor interest into the final number. The reason we are using such a simple number is that it’s relatively easy to get, and it’s one no-frills standard that everyone can use. (Even as the MBAs among you may dislike it.) This is the back-of-the-envelope number, not the precision calculation, but that makes it easy and fast.
How does this help me determine success?
CLV simply lets you see clearly what you’re getting out of a customer versus what you’ve put in. Having insight into your revenue streams can help you dictate your go-to-market strategy. Additionally, CLV helps you answer one of the most important questions anyone can ask about a business: Did it make more money from a customer than it spent to acquire that customer?
CLV can help you craft an accurate budget
According to Ruth Stevens, President of eMarketing Strategy, “The expected lifetime value of a customer represents the maximum allowable acquisition cost of that customer. Then using those numbers, you can craft a marketing budget that is related to firm profitability versus some fussier method of budgeting for marketing expenses.”
The more predictable your revenue streams are, the better. If you know exactly how much money will be flowing through your company this year, next year, and beyond, you’re already off to a good start for budgeting and creating sustainable growth.
CLV helps you answer critical questions like…
- Are you finding your most valuable customers?
- Are you targeting them effectively?
- Are you making the most of the relationship once you win their business?
After you’ve calculated the CLV, you can begin to look at how much you spent to acquire this customer. Was it worth it? If so, dive deeper into what made this such a great customer. Was it the industry they were in? The size of the company? Knowing this can help you figure out your ideal customer profile, and how you can get more customers like that one. You may find that you have multiple segments of customers, some more valuable than others. You could potentially justify spending more to acquire those customers.
Is everyone calculating CLV?
CLV is just one small piece of the puzzle. While just 42% of companies could measure CLV in 2014, we’re seeing organizations move away from a strict focus on the sale, and shift toward a focus on the customer. Marketers are being asked to care for the welfare of customers long after the deal is signed. Organizations are beginning to realize that customer success is a key ingredient to any healthy business. Most B2B firms are now spending a lot of time and effort avoiding “one and done” customers — ensuring that the money they spend to acquire customers today also generates returns for years to come.
In fact, according to a seminal study published in Harvard Business Review, increasing customer retention by 5% can increase profits by 25% to 95%.
Marketing Automation and Customer Lifetime Value
Marketing automation reports and dashboards make it quick and convenient to review and analyze tons of customer intelligence, including demographics, campaign engagement, website visits, and purchase history. This information – often available in real time – is helpful for identifying cross-selling and upselling opportunities – great ways to increase the value of your customers! Behavior history profiles can also uncover likely follow-up sale products based on each customer’s pre-purchase and post-purchase interactions.
Do you have what it takes to calculate CLV?
The short answer is, yes!
One of the most useful aspects of CLV is its flexibility. Getting started requires nothing more than some fundamental marketing data, a common-sense approach to calculating cost and value metrics, and a commitment to applying these tools as consistently as possible. In fact, using the metrics consistently is more important than getting them 100% accurate.
With the inundation of success metrics that marketers are being asked to consider, why add one more? Well, customer lifetime value (CLV), when considered in relation to the cost of acquiring a customer (customer acquisition cost, aka CAC), yields the B2B marketer’s version of a pocket compass, providing a “true north” metric of success. We call that the Compass Quotient. You can read all about it – including how to use it to evaluate your marketing – in our new eBook, Finding “True North” on Your Marketing Compass.