What is customer lifetime value?

The customer lifetime value (also called customer lifetime value or customer lifetime value) allows us to establish the value of our customers in advertising terms.

In this way, we can find out how much we should invest in our advertising campaigns. This means estimating the cost of acquisition by analyzing the customer life cycle, i.e. the evolution of customer behavior and preferences over the duration of their relationship with a company.

why is it important to know the Customer Lifetime Value?

Generally, we tend to estimate the cost of advertising based on estimated revenue. For example, if we deploy a promotional campaign to sell a product with a margin of $50, we try not to invest more than $25 in advertising to ensure an acceptable revenue.

However, we must keep in mind that a customer may buy again, especially if our products are of basic necessity or are upgraded in terms of improvements and features. It is then when we need to know if the advertising we carry out is not preventing a recurrence of purchases.

This is when customer lifetime value comes into play, as it allows us to classify our customers according to the benefits they bring us if they make a habit of buying from us. Based on the information gathered throughout the customer lifecycle, we can decide whether or not to invest in loyalty campaigns, sales growth and sales diversification.

but is there a way to know exactly? In other words, is it possible to establish the exact customer lifetime value with a formula?

Customer lifetime value: formula

To calculate the customer lifetime value, the formula we need must include 3 factors related to our customer: the average spend, the recurrence of acquisition and the lifetime of the customer.

The average spend (for simplicity, we will call it G) is the amount of money that, on average, our customer spends buying the products or services we offer. Recurrence of purchase (R), on the other hand, is the number of times the customer has made a purchase with us in a given period of time (e.g. one month, six months, one year, etc.). And the customer lifetime (V) is how long we expect the customer’s life cycle to last.

Once we have these data, we calculate the customer lifetime value (CLV) with the following formula:

CLV = G x R x V

To understand it better, let’s assume that a customer usually buys flash drives in our online store about 3 times a year (R = 3), spending with us an average of 150 € (G = 150). If we want to know what will be the customer lifetime value of that customer for the next 5 years (V = 5), we just have to calculate:

CLV = 150 x 3 x 5 = 2,250 €

It is important to note that all variables have to be adjusted in the same unit of time. This means that if, for example, you calculate the acquisition recurrence in months and the customer life cycle in years, the customer lifetime value will give us an incorrect number.