How to Calculate Customer Lifetime Value In Ecommerce?

4 min read

What good is a customer if they only buy from you once?

In ecommerce, the relationship between brands and customers shouldn’t end with a sale. In fact, if you are implementing forward-thinking practices in digital marketing, the first sale will be the beginning of a long and prosperous relationship.

In this article, we’re going to explore the topic of customer lifetime value and explain how your business can benefit from getting acquainted with this valuable metric.

What Is Customer Lifetime Value?

The short definition of customer lifetime value, or CLV, is this:

It is the financial value that each customer contributes to your company throughout their entire relationship with your business.

Knowing this value gives you a clear perspective of the benefits of acquiring new leads, and maintaining relationships with any of your customers.

It’s important to realize that not all customers are equal. Studies indicate that the top 1% of your customer base could be worth 18 times as much as the average customer.

By applying a modified version of Pareto’s Principle, you can focus your resources on the customers that really matter. This will save a lot of wasted time, money, and effort that would otherwise be spent on customers who will invariably deliver a poor return on investment (ROI).

However, before you can implement such a strategy, you need to calculate CLV. Unfortunately, that is not as straightforward as you may anticipate.

Indeed, the complicated formula can deter many marketers from even trying, which begs the question:

Is it really worth the hassle?

Why Is Customer Lifetime Value Important?

In ecommerce, extending the Customer Lifetime Value (CLV) is a vital step towards developing longevity and stability for your business.

CLV is often disregarded, but the reality is that it can be a massive help for gauging the current health of your business, and for projecting future success.

Put simply, it tells you how much your customers are really worth. How valuable is each and every customer to your business? What are they contributing towards your goals of sustainable growth and profits?

When you gather these insights on each of your customers, you can determine which ones are worth your time and resources, and which ones are not.

From there, you can reap several benefits, such as:

  • Better ROI per customer acquisition – more financial freedom to acquire long-term customers
  • An enhanced retention strategy – with a view to the future, you’ll build relationships that last
  • More personalized brand messaging – by segmenting your customer base to focus on the high-value customers, your content will be more targeted to nurture these relationships
  • Improved customer support – with the special attention on your top customers, your services and customer care will improve, helping foster stronger ties

Key Metrics to Know Before You Can Calculate CLV

Okay, so let’s see how we can calculate customer lifetime value. To do this, you actually need to make several calculations, which incorporate multiple key metrics.

We’ll take it one step at a time.

1. Calculate Average Purchase Value

The average purchase value is the average value of each purchase your customer made. Also known as average order value, it’s one many retailers aim to improve in ecommerce.

You can calculate this value by dividing the total revenue your business made in a defined time period (e.g. one month, one year etc.), by the total number of purchases that the customer made during the same period.

2. Calculate the Average Purchase Frequency Rate

The average purchase frequency rate is the number of times a customer buys something from you.

You can calculate this rate by dividing the total number of purchases made during a time period by the total number of unique customers that made purchases throughout that same time period.

3. Calculate Customer Value

Note that customer value is not the same as CLV.

To calculate customer value, multiply the average purchase value for the customer by 1. Then, take that number and subtract the average purchase frequency rate.

4. Calculate Average Customer Lifespan

Before you can calculate the CLV, you must work out how long the customer will stay with you. Consider the average lifespan of your customers to make an educated projection of how long the customer’s lifespan will be.

How to Calculate CLV for Your Ecommerce Business

After you have completed the calculations above, you will be able to work out the customer lifetime value (CLV) for your customers. To do that, you must multiply the average customer lifespan by the individual customer value.

The resulting value will be an estimate of the revenue you could expect from that customer throughout their relationship with your business. And there you have it!

The customer lifetime value is easily one of the key metrics for anyone in digital marketing to be tracking.

It’s important to know just what each customer is worth to your business, especially when it comes to making financial forecasts and addressing any budget concerns.

But the benefits don’t stop there.

If you measure CLV compared to the cost of acquisition, you can make accurate projections on how long it will take to recoup the initial outlay on sales and marketing.

Finding Your Most Valuable Customers is Worth the Effort

There is a lot to be gained by nurturing long-term relationships with customers. The longer they continue buying from you, the higher their value becomes.

While the calculation for CLV is somewhat convoluted, it is worth completing so that you can identify the customers that are worth investing your resources in.

Taking the time to work this value out for each customer will allow you to home in on your top customers. That way, you can save time and money, and improve your services to generate the best possible return on your marketing efforts.

 

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