Customer Lifetime Value — Chapter 1

What is CLV?

CLV (Customer Lifetime Value) is a prediction of all the value a business will derive from their entire relationship with a customer. Because we don't know how long each relationship will be, we make a good estimate and state CLV as a periodic value — that is, we usually say “this customer's 12-month (or 24-month, etc) CLV is $x”.

The Pareto Principle states that, for many events, roughly 80% of the effects come from 20% of the causes. When applied to e-commerce, this means that 80% of your revenue can be attributed to 20% of your customers. While the exact percentages may not be 80/20, it is still the case that some customers are worth a whole lot more than others, and identifying your “All-Star” customers can be extremely valuable to your business.

Taking CLV into account can shift how you think about customer acquisition. Rather than thinking about how you can acquire a lot of customers and how cheaply you can do so, CLV helps you think about how to optimize your acquisition spending for maximum value rather than minimum cost.


Let's Go Fishing

Consider that acquiring customers is like fishing. You might go fishing in the Adwords Ocean, Facebook River, or Lake Microsoft. Under a cost minimization strategy, the results of your strategy might look like this:

Location Total Spend Customers CAC*
Adwords Ocean $100 100 $1
Facebook River $150 50 $3
Lake Microsoft $250 25 $10

* Customer Acquisition Cost; also known as “Cost Per Acquisition (CPA)”

You might think that the Adwords Ocean is the best because it gets you customers for the lowest cost, but looking at Customer Acquisition Cost is only half the equation. We also need to consider that the lifetime revenue of customers from each of these channels might be different.

Location Total Spend Customers CAC CLV Revenue Profit *
Adwords Ocean $100 100 $1 $10 $1000 $900
Facebook River $150 50 $3 $30 $1500 $1350
Lake Microsoft $250 25 $10 $100 $2500 $2250

* Profit is defined as Revenue – (number of customers × CAC). For the sake of this exercise, it does not take into account other costs.

When you consider not just the acquisition cost, but also the value the customer will bring to your business, your acquisition strategy can be fine-tuned and result in better customers for less money. In that case, you may prefer to fish in Lake Microsoft since it has the highest overall profit of the three channels.

But how do you measure a customer's value? Continue on to learn about different ways to calculate CLV…

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