The Customer Lifetime Value is a data that allows a company to know what can be spent on marketing to acquire a new customer.
The concept of the Customer Lifetime Value (CLV) has the great advantage that an almost exact economic amount can be calculated which allows us to find out the benefit of it.
What is the purpose of the Customer Lifetime Value?
The CLV is interesting for all those companies that want to invest in marketing. Why do we advertise? In the end we want to get new customers. If I spend 100 euros I want 200 euros inreturn (depending on the sector the margin is lower or higher). The vast majority of companies do not know what can be spent because they do not know the real value of a client.
The calculations that are usually made to calculate the maximum cost of a customer acquisition campaign are typically based on a single sale. If I advertise to sell trips that gives me a margin of 200 euros I try not to spend more than 100 euros on advertising to have an attractive benefit. What is not taken into account is that the same customer could repeat their purchase. If suddenly we realize that this average customer is going to buy that same trip for 3 years instead of spending 100 euros we could spend up to 300. For this the company has to have a financial cushion large enough to finance the first year in which the relationship still does not generate a positive cash flow.
How to calculate the Customer Lifetime Value?
Let us see an example of CLV calculation based on a case study with Starbucks. Before starting, we need some basic information:
- Purchase average from a Starbucks customer: $ 5.90 on each purchase
- Frequency of purchase per week: 4.2 per customer
- Duration of the relationship (membership): 20 years (I did not even know that Starbucks has been around for so long)
- Margin: 21.3%
There are 3 different ways to calculate the CLV:
- Simple CLV: based on the 3 previous metrics (average purchase, frequency and ownership).
- Real CLV: based on the simple CLV but multiplying it with the margin of the product.
- Discounted CLV: discounting future cash flows (100 euros today are worth more today than within 10 years).
The real CLV makes sense for 80% of the businesses and if we talk about start-ups it will probably be 99%. The simple CLV does not take into account my costs and the discounted CLV requires data on a very long relationship with the client that in newly created companies typically do not exist. So let’s take out the figures to find out, with the help of the real CLV, what we could spend on marketing for the acquisition of a new client.
Real CLV = purchase average x purchase frequency / week x membership x margin x 52
= $ 5.90 x 4.2 x 20 x 0.213 x 52
= $ 5,489
According to the data obtained, Starbucks can be spent up to $ 5,489 per customer. The CLV is a dynamic data that changes depending on how a business is evolving. Sometimes the average of the results of the different types of CLV is also taken (simple, real and discounted).
Since the Customer Lifetime Value provides more reliable information when a history already exists, it can not always be applied to the world of start-ups. Apart from the lack of data, financial stability is also required because the CLV bets on a long-term relationship return that initially generates negative cash flows. Over time and with more data the CLV becomes a more solid metric and incredibly valuable for a business.