As any entrepreneur knows, finding a sustainable way to grow your business can be difficult even under ideal circumstances.
Whether you’re new to the professional world or you’re a seasoned veteran within your industry, you know you’ll need to gain new customers if you want to grow. But you also need to figure out how to keep your existing customers around.
There’s an old adage that says it costs five times more to bring on a new customer than to keep an old one. But even if that’s not quite accurate for your business, customer retention is still much more cost-effective than customer acquisition.
Simply put, it’s essential that you’re investing the right amount of time and resources into your current customer relationships in order to grow your business over time. And while there are many key performance indicators (KPIs) and other metrics that can provide insight into this area, customer lifetime value is among the most vital.
Let’s take a closer look at what you should know about customer lifetime value as it relates to the growth of your business.
What is Customer Lifetime Value?
First of all, what is the lifetime value of a customer? Customer lifetime value, which is sometimes shortened to CLTV or LVC, basically tells you how much a given customer relationship is worth to your company.
It’s a measure of how much money they will spend with your business – or how much revenue you might expect them to generate – throughout the life cycle of that relationship.
The more established the relationship, the more you might expect that a customer will spend; understandably, a customer who stays with you for three years will likely spend more than a customer who stays with you for only three months. As such, LVC is a good indicator of customer loyalty. Lower LVCs are often associated with a greater risk of churn, while higher LVCs are usually associated with customers that have a great relationship with your brand.
It’s important to note that customer lifetime value and customer acquisition cost are two different metrics, though they are related. While acquisition costs refer to how much your company might spend to bring a customer on, LVC shows you how much your company stands to make with that customer once they start doing business with you.
Why Does Customer Lifetime Value Matter?
Now that you understand what LVC is, at its most basic level, you might still be wondering why it’s important.
Without knowing your average customer lifetime value, you’ll have no choice but to make a wild guess as to how much a given relationship is worth. While you might want to give each and every customer the same caliber of service, the reality is that you might not see the financial return on some of those customers.
For example, if you’re targeting an audience of folks who can’t really afford your services on a recurring basis, sinking extra time and money into those relationships simply won’t pay off. That doesn’t mean you shouldn’t care about these customers at all, but it does mean you need to be more strategic about where you’re spending your valuable resources.
If most of your customers come with higher churn rates, you’re going to spend all of your efforts on maintaining relationships that simply aren’t going to grow your business. But if you’re looking to create a strong base of clientele that are loyal to your brand (and are inclined to make more than just a one-time purchase), you’ll want to make sure you’re putting your efforts into the right relationships.
Understanding the value of your client relationships can ensure you make the right decisions pertaining to marketing, lead generation, customer service, and even staffing. In the end, you’ll want to know you’re getting more (or at least as much) out of these relationships as you’re putting into them. That’s the only way your business operations will be sustainable.
How Can You Calculate Customer Lifetime Value?
Now that you understand what CLTV is and why it’s such an important metric for your business, it’s time to learn how to calculate it for yourself.
Ultimately, customer lifetime value will be a bit of an estimate. There’s really no guarantee that a current customer will spend as much as you think they will; unforeseen circumstances happen all the time, after all. But if you have a solid idea of what you can probably expect, that’ll allow you to make more sound business decisions than a wild guess or a mere hope will.
In order to figure out the lifetime value of your customers, you’ll need to factor in a number of other figures. You’ll need to take into account your customer churn rate, the average customer lifespan, the median invoice you send, the average number of new customers you acquire every month, your monthly sales and marketing costs, and more.
Many business owners that’s a lot to figure out on their own. Using a customer lifetime value calculator is one of the easiest ways to ensure your metric is as accurate as possible and that it’s easy to track. With tools like these, you can simply plug in the numbers and the tool will automatically calculate your LVC.
Once you have your LVC, you can determine whether you’re spending too much or too little on your existing customer relationships. And if you find that you need to improve your LVC across the board, you can prioritize customer service improvements, send out customer surveys, or devote a larger portion of your advertising budget to retargeting.
While it might not always be the most pleasant task, you’ll want to face this challenge head on and know exactly what you’re dealing with. If your LVC is higher than expected, you’ll at least know you’re on the right track. And if you’re seeing lower LVC rates than you want, you’ll have a better idea of what can be improved.
When you want to grow your business, having a clear understanding of customer lifetime value is imperative. Without this metric, you won’t know for sure whether you’re targeting the right customers or whether your approach needs to change. But with it, you can make more informed decisions that will support your ultimate business goals.