How to quickly (and really) identify the value of your customer

Your business has customers, but they're not all created equally. 
​
Some customers might purchase one product or service and leave. Others become loyal supporters and purchase many products or repeat service purchases over the course of a year, or two, or more. Which customer is then more valuable to you? 

Obviously the second group, but you need to be measuring lifetime value to know that. You need to know if the audience you are attracting is increasing or decreasing this value for your business. The way to measure it is known as your CLV, or Customer Lifetime Value. Knowing the CLV for different customers will greatly help you with business decision-making and business profitability.

Using the CLV metric, you can also determine, among other things:

• What products/services are in demand by customers with the highest CLV.
• Which products/services have the highest profitability index.
• Who your most profitable types of clients are.
• Which customer relationships are driving more than 80% of your sales.
• How much you can afford to invest in acquiring similar customers with a good profit margin.
• The exact amount you forecast an average customer will be likely to purchase over time.
• How you can understand the likes, desires and reasons your most loyal customers purchase from you.
  

How do you know how much you can spend on advertising to acquire a valuable customer?
​
So, to arrive at this number, we need some data. We need to know:

• your average annual purchases per customer, 
• the average profit per purchase, 
• and the average number of years you keep a customer. 

​
Let's use the example of a low-involvement product, i.e. dog toys that you sell online, and you pull up your e-commerce data.First, you might see that most of your customers have two transactions within your store, so they checked out twice in one year. You then see that the average order is $50. But you know that your average markup is 50%, so you only profited $25 on that order. As each customer averages two transactions a year, and each transaction profits $25, it means each customer averages $50 in profit to the business per year.
Finally, you see that most of your customers typically stay engaged for another year, and that makes their retention rate about two years. If we were to plug all of the numbers together:

• Two transactions x $25 profit x two years = your customer lifetime value of $100. 

And here you have the simple formula for Customer Life Time Value (CLV):
average profit per transaction (or value of the purchase) x average annual transactions x average years customers remain loyal. ​

A few more examples of how to use this formula:

With this, you can start leveraging the data. That means retaining customers. If they stick around another year, you make more money. 

What works? It depends on the product or service you're selling, so this stage will be tailored to your existing customer base and your business growth stage. The strategies may include:

• Customer relationship management via email marketing, sales and special offers.
• Increasing the average transaction value by upselling or recommending other products.
• Identify budgets for advertising using a quick formula: If a customer is worth $200 to us, how much are we willing to spend to acquire them? Perhaps we would spend $50 to bring in a customer. So for every $50 we spend, we have a gross profit of $150. Knowing this figure, you can start running paid ads, and work to optimise them to a cost per acquisition of $50. 

Knowing how much you can expect from an existing customer can give you a clear and updated picture of the health of your business.

If you find your customer lifetime value is declining over two consecutive quarters, for example, you might invest more into retention and customer service. You might want to use surveys or have direct conversations with customers, if possible, to identify the reasons.

While not the only factor that affects customer lifetime value, customer satisfaction does play a key role. If there's a difference in quality of service between a customer's first and their third purchase, i.e., CLV will likely decline.

CLV should be one of the most important metrics you track.

Next time you take a long look at your business profitability, take time to calculate your customer lifetime value and decide where adjustments in your strategy are actually due.