Unleash the CLTV Secret: Skyrocket Your Marketing ROI with High-Value Customers
Customers who are acquired through marketing should be assessed to determine whether they can bring value within a specific timeframe. You may have the same questions as me:
- Do I acquire high-value customers?
- Do I know when I will receive a return on my investment after acquiring new customers?
- How much did I spend on acquiring new customers based on last year’s customer acquisition data?
The purpose of this article is to assist businesses to identify high-value customers, effectively allocating marketing resources, and developing strategies to maximize customer retention.
CLTV and Its Advantages
CLTV (Customer Lifetime Value) is an essential task for enterprises as it helps identify the value of customers throughout the business relationship. There are several advantages to conducting CLTV analysis:
- Customer acquisition and retention, CLTV analysis assists businesses in understanding the profitability of acquiring and retaining customers. By focusing on acquiring similar customers, businesses can maximize customer value and loyalty.
- Marketing effectiveness, CLTV analysis evaluates the effectiveness of channels and campaigns. This enables businesses to optimize their marketing strategies, leading to better Return on Investment (ROI)
- Customer segmentation, CLTV analysis aids businesses in segmenting customers based on similar CLTV ranges. This allows for tailored marketing, product offerings, and customer service that cater to the unique needs and preferences of each segment
Here is the common calculation of CLTV:
CLTV = (Average Purchase Value) x (Purchase Frequency) x (Customer Lifespan)
Regarding the formula, CLTV can be further refined with additional factors such as customer acquisition cost, and customer churn rate. These factors provide a more accurate estimate of the long-term profitability associated with customers.
Disclaimer: The example and problem-solving for the rest of this article will use a cohort analysis approached
Customer lifespan refers to the duration during which a customer actively engages with a business, making purchases or utilizing its products or services. This duration is typically measured in months or years, depending on the specific business and industry. To illustrate the concept of customer lifespan for CLTV analysis, let’s consider an example based on cohort analysis:
Cohort A: Customers acquire in January 2020
- Customer 1: First purchase on January 01, 2020; Last purchase on December 30, 2020 (12 months)
- Customer 2: First purchase on January 15, 2020; Last purchase on October 15, 2020 (10 months)
- Customer 3: First purchase on January 21, 2020; Last purchase on November 30, 2020 (11 months)
To calculate the customer lifespan, you need to measure the duration between the first purchase and the last purchase for the customers in each cohort. Here is the lifespan of cohort A:
- Cohort A, the lifespan ranges from 10–12 months, with an average of around 11 months
Purchase Frequency & Average Purchase Value
Purchase frequency, also known as a purchase rate or buying rate, measures the number of times a customer place orders within a specific period. For example, if customer A makes 100 purchases in a year, the purchase frequency would be calculated as 100 purchases divided by 1 year, resulting in a purchase frequency of 100 purchases per year. Let’s delve into the calculation of purchase frequency:
Purchase frequency = Total Number of transactions / customer lifespan
For instance, let’s consider three customers with transaction counts of 10, 18, and 15 transactions, the customers have utilized the service or product for around 1 year and a half, resulting in an average purchase frequency of approximately 28 transactions per 1 year and a half.
Average purchase value, also known as average order value (AOV), represents the average monetary value (selling price) of individual purchases within a specific period. Typically, businesses include the total spending of the company for each transaction, such as the buying price of the products. The calculation for determining the average purchase value is as follows:
Average Purchase Value =
(Total selling price-Total buying price) / Total number of transactions
For instance, let’s consider customer A who has conducted 100 transactions, resulting in a total revenue of approximately $3,000. Additionally, the business incurs a cost of $500 to send orders to customers. Therefore, the calculation for the average purchase value would be ($3,000 — $500) / 100, which equates to an average purchase value of around $25.
Practical Example of CLTV
Let’s calculate the CLTV for the dream company. The company intends to analyze the acquisition that took place in January 2020. Their objective is to determine the amount of money that should be spent in February to achieve profitability. Here are the step-by-step instructions for calculating the CLTV based on the January 2020 acquisition:
Customer acquisition in January 2020, with the Cost of Acquisition (CAC) of around $200
- Customer 1
- Lifespan: 12 months
- Purchases: 20
- Total revenue: $440
- Company cost: $53
- Customer 2
- Lifespan: 13 months
- Purchases: 14
- Total revenue: $450
- Company cost: $62
- Customer 3
- Lifespan: 11 months
- Purchases: 10
- Total revenue: $320
- Company cost: $20
Let’s take all metrics and calculate each variable to get CTLV:
- Cohort lifespan ranges from 11 to 13 months, with an average lifespan of approximately 1 year
- Average purchase value
= (($440–$53)+($450–$62)+($320-$20)) / (20+14+10 purchases)
= $24.4 per purchase
- Purchase frequency
= (20+14+10) / 1 year
= 44 purchases per year
- CLTV for customers that acquire in January 2020
= $24.4 per purchase * 44 purchase / year * 1 year
= $357.8 per customer
In the practical example of CLTV, you have evaluated the CLTV based on the cohort acquisition in January, with a CAC of approximately $200. The result indicated that the CLTV amounts to $357.8 from the customer in the following year. In order to get profitability for the next year, you might not spend more than the CLTV, your acquisition cost should be lower than CLTV.
CLTV is a crucial metric that estimates the total value a customer brings to a business over their entire relationship. It is an important concept for businesses as it provides insight into the long-term profitability of customers and helps the business to create a robust strategic decision related to customer acquisition, retention, and marketing efforts.
The above explanations with practical examples might be your fundamental study to utilize with various cases such as CLTV for the specific channel of marketing like Facebook ads, Google ads, and programmatic channels.
Now it is your turn to apply CLTV in your business and organization, talk to your marketing manager and work with a data analyst to assess your business value.
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