Your Customer Lifetime Value (CLTV) is an important metric.
It can help you to determine how much money you can spend to acquire new customers and is useful to determine financial impact when you’ve changed prices.
How To Calculate The Customer Lifetime Value
There are many different ways to calculate the CLTV. Each method will produce slightly different results. One of the best practices is actually use all three methods and take the average from those as your ‘true CLTV’. However, this is not necessary and sometimes one calculation is all your business need.
To demonstrate the equations we will use the following figures:
- Average Customer Spend / month = $100
- Average Customer Lifespan = 12 months
- Margin = 15%
- Discount Rate = 10%
- Retention Rate = 60%
The Simple Method
The simple method takes very little time to calculate, yet it is not the most accurate. The equation for this model is:
Average Customer Spend X Average Customer Lifespan = CLTV
In our example the value would be: 100 X 12 = $1,200.
This model fails to include costs for delivering the service. Therefore, you might overspend believing you have more funds available to acquire new customers.
However, if you have very few overheads, this might be all you need to calculate your customer’s lifetime value.
This is still a very simple method, but it allows you to include the costs for delivering your service. This is a perfect equation for those who offer a subscription for a physical product such as wine, specialist food or DVDs.
Average Customer Lifespan X (Average Customer Spend X Profit Margin)
So with our example figures:
12 X (100 X 0.15) = 12 X 15 = $180.
This figure is lower than the simple version but it is far more accurate and allows you to calculate a reasonable acquisition budget without having to worry about costs.
This equation is the more accurate; however it is the most complex and should be used only if you want a precise valuation.
The new metrics used in this calculation are:
The Rate Of Discount = The interest rate used for calculating the present value of future cash flow. This number is usually between 8% and 15%. This value assumes prices aren’t going to increase in the immediate future.
Retention Rate = A calculation for a subscription business. It is simply the percentage of customers who remain with your service from month to month.
Average Gross Margin Per Customer Lifespan = This is how much profit each customer provides during their lifespan. To calculate this use your final figure from the simple method and then multiply it by the profit margin. For our example we have 1,200 X 0.15 = $180.
The CLTV equation:
Average Gross Margin Per Customer Lifespan X (Retention / (1 + Rate Of Discount – Retention))
In our example this would equate to:
$180 X (0.60 / (1+ 0.1 – 0.6) = 180 X 1.2 = $216.
You can then use all three figures to calculate an average Customer Lifetime Value, however you might prefer to use just one of these figures.
How To Use These Figures
Whichever method you use, you can now calculate the maximum spend to acquire new customers. For instance, if you use the traditional method you know you can spend up to $216 to acquire each new customer. Sticking to this value means each customer you have is allowing you to stay in profit over the long period.
Working out the CLTV for your business is an essential task. It can support you in your marketing budgets ensuring you aren’t spending too much. In addition, you can see the results of any price changes and note whether the price change had a positive effect on your business’ finances.
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