CLV: what is it?
Customer Lifetime Value or CLV is a typical metric for ecommerce and all businesses that base their analysis on purchasing behavior. It is a measurement method intended to understand what value a customer will generate over time by making an assumption based on the average value of transactions over a time frame.
Let’s start with an example: a user buys from a store 5 times a year for a value of about 20 euros, and let’s assume that the user can buy for another 2 years in the same ways. The value the user generates for the company is equal to 5 x 20 x 2 = 200 euros. To simplify, we have used a “gross” measurement, but the CLV should be calculated on the real average value of the user, thus on the profit margin that the company can estimate over time excluding all costs, including management costs. Assuming that on each product the company has a margin of 6 euros, the CLV will be equal to 5 x 6 x 2 = 60 euros. There are several ways to calculate CLV In this infographic from Kissmetrics you find three formulas from the simplest to the most elaborate.
Why is CLV important?
This metric is used, among other things, to understand how many sales or how long it takes to “pay back” an investment in acquiring a new customer. If, in the previous case, we spent 1 euro to acquire the contact, it will only take one sale to pay back. If, on the other hand, the acquisition cost was 8 euros, we would have had to wait for the second purchase by the customer to be profitable. In general, if the margin is low, repeating transactions over time is vital, precisely to optimize the costs incurred in finding new customers. If the margin is high, retention may be a less critical factor, but only on the surface. In fact it remains a necessary key to building a solid and lasting business. It goes without saying that this is all the more true for ecommerce with business models based on products with a high repurchase frequency.
CLV serves to:
- Establish budgets for generating a new client
- Building projects to increase this value
- Operate strategically to improve the ratio of acquisition cost, revenue while taking scalability into account (it is not necessarily the case that so many new customers mean more profits)
- Investing in higher-value user segments to offset lower-value ones
CLV is a very challenging metric because it works in the positive. It is not just about reducing costs, but about lengthening the time of relationship with the most valuable users. Growingengagement is not just about “opportunity,” it is an opportunity to improve the overall brand perception in the consumer. Targeting the customer experience is one of the keys to success for many major brands.
As stated in this very insightful article Avinash Kaushik “If we can identify channels, campaigns, media or propositions that deliver “better than average” customers we can begin to see how much more profitable they are and decide how much more we should be spending on them.” Knowing then allows us to get a clear picture of the profitability of our user segments and study precise strategies for them to increase their value over time. Personalization and a multichannel approach are therefore the levers to be operated to improve the results of each segment, lengthening the life cycle and increasing the overall average value.
