Everything You Need To Calculate Customer Lifetime Value

How do you calculate customer lifetime value? Why is it so important to the success of your marketing campaigns and to your business overall? Let’s answer those questions and provide the tools you need to calculate this most valuable concept.

What is Customer Lifetime Value?

Customer Lifetime Value is how much you expect to make over the lifetime of a customer time with your company. It’s not about how much money you make on a particular sale, but how many sales you can expect going forward from that sale. This is going to directly inform how much you can spend on acquiring new customers (read a nice breakdown on calculating CLV from Qualtrics).

This formula also explains why companies are often willing to pay more to acquire a new customer, than the margins for an initial sale would seem to allow. If you’ve seen Google Pay-Per-Click rates that are astronomical for industries such as law and healthcare, you now know why. Any industry that charges either high prices up front or expects to have the customers for a long period of time (i.e. a subscription service) will often have a very high cost of customer acquisition.

Below is a simple (but flawed) calculator for customer lifetime value. Try it out, but make sure to jump to the next section before you use the numbers. Be thinking: “what is the problem with this formula” along the way.

Customer Lifetime Value Calculator (simple)

1

Enter the Required Details

Fill in the average purchase value for a particular product you sell.

2

Enter The Purchase Frequency

Enter how many times you expect the customer to purchase products.

3

Enter Customer Lifespan

Enter how long (in years) you expect your customer to remain a customer.

Customer Lifetime Value Calculator




What Was The Problem With This CLV Calculator?

Perhaps the most important rule of analytics or data analysis of any type is that one must be extremely careful about what you average. If you have different products that the customer will buy along the way, you might realize that all customers are not in fact the same. A lesson from statistics, curtesy of Major League Baseball is Simpson’s Paradox

In both years 1995 and 1996, Derek Jeter had a lower batting average than David Justice however Derek Jeter’s combined batting average for the two years was higher than David Justice. How did it happen?

Don’t freak out. The stat is real and it’s actually pretty intuitive. Jeter’s average of .250 in 1995 and .314 in 1996, is less than Justice’s .253 and .321 respectively. However, in 1996, Jeter took more at bat.

Year
Batter  
19951996Combined
Derek Jeter12/48.250183/582.314195/630.310
David Justice104/411.25345/140.321149/551.270

Example of a More Advanced Customer Lifetime Value Calculator

With this in mind, if you sell a variety of products (especially if there’s a great range to the cost of the products), you’re going to want to account for segmentation. Different customers buy different products and your CLV needs to attempt to account for it.

In whatever CLV calculator you use, you’ll want to add a “Customer Segment” dropdown where you can select the customer segment. Each segment should be divided by a value that acts as a multiplier in the CLV calculation. This adds another layer of granularity to your CLV calculations and can provide a more accurate representation of the CLV for different customer segments.

Now keep in mind, we still have the averaging problem. Simply lumping customers into these generic categories “high spending, long-term” customers is fairly simple. Depending on the type of company, the industry and the different products you have, you will likely need to adjust your formula.