Understand, Calculate, and Increase Your Customer Lifetime Value (CLV)

Customer Lifetime Value (CLV) is one of the most important metrics for determining the success of your business. In fact, it’s one of those metrics that simply cannot be ignored, especially if you run an eCommerce business.

Despite the importance of CLV, only a few business owners fully understand what it is, how to calculate it, or how to increase it. Therefore, in this article, we’ll cover everything you need to know about customer lifetime value: from CLV definition and calculation to effective strategies you can use to boost it.

What is Customer Lifetime Value (CLV)?

If you’re here, you’ve surely heard the abbreviation CLV and may already have an idea of what it means. However, to ensure the rest of this article is fully understandable, we need to define CLV precisely.

💡 Customer Lifetime Value (CLV) is a metric that estimates how much money you will earn from each customer over the entire period they remain your customer.

By definition, customer lifetime value is, in essence, a forecast of the total profit a customer is likely to generate for the company over the entire duration of their relationship with it. It is important to emphasize once again that CLV does not reflect the total amount of money a person has already spent with you, but rather an estimate of how much they are likely to spend in total over the entire period they remain your customer. CLV should be regularly measured and monitored, especially for customers with whom you have long-standing relationships.

When it comes to eCommerce businesses, increasing CLV is often closely linked to boosting customer loyalty and satisfaction, as well as encouraging customers to make repeat purchases at the store. We’ll discuss the most effective ways to boost CLV in detail below.

Why is Customer Lifetime Value Important?

The importance of the customer lifetime value benchmark lies in the possibilities of analysis and prediction that it provides. It allows companies to quantify the long-term value of customers.

It represents the greatest importance for a subscription business with permanent sources of income or for companies that sell goods with high initial costs that need to be recouped over time. By calculating CLV, companies with subscription plans will be able to calculate how cost-effective their plans are, and brands with high initial costs will be able to assess whether their plans will pay off at all.

In fact, there are many reasons why CLV is so important that many companies use it as one of their key performance indicators (KPIs). Learn about the main ones for these reasons below:

High CLV Equals High Revenue Per Customer

Calculating CLV is important because it provides valuable insights for brand owners’ marketing and sales initiatives.

A high CLV means your customers are spending a significant amount of money in your store, likely due to regular purchases or buying higher-priced items. This is great because it stands to reason that the more customers spend with you, the more revenue you’ll generate.

Meanwhile, a low CLV means that customers aren’t willing to spend their money regularly at your store, preferring inexpensive items over expensive ones, or constantly waiting for sales and discounts before buying anything from you.

💡 Another of the many benefits of the CLV metric is that tracking CLV over time helps businesses see how changes in their business model affect customer profitability.

The Link Between CLV and Customer Acquisition Costs

The higher the CLV, the more valuable each customer becomes. High benchmark figures mean you can focus more on retaining existing customers than on acquiring new ones. Detailed CLV data allows you to accurately identify which types of customers spend more, so you can target your marketing campaigns at those customers.

The CLV benchmark is closely linked to customer acquisition costs (CAC). If you know how much each customer is worth in the long term and compare that figure to your customer acquisition costs, it becomes easier to understand which marketing channels work best for you overall.

💡Having a low CLV means you’re not getting enough value from your current customers. In this case, the best solution for you is to focus on acquiring new customers, rather than spending time retaining customers who aren’t yet generating enough revenue for you.

CLV as the Key to Boosting Customer Loyalty and Retention

Tracking your online store’s CLV over time can help you figure out exactly what motivates customers to stay with you rather than buy similar products at another store. If you can spot the early signs of customer churn, you’ll have a better chance of finding a way to retain them before they leave.

In other words, calculating CLV helps improve customer loyalty and retention because it helps companies identify patterns in customer interactions, especially positive ones.

💡 The primary importance of the CLV metric lies in the fact that it helps companies identify opportunities to reduce customer churn and increase profitability.

Customer Lifetime Value Prediction Models

CLV, as a method for calculating the revenue a company expects to generate from a customer over the entire duration of their relationship, can be useful for making decisions about which customers to prioritize, as well as how much to allocate to marketing and customer service. There are two main types of customer lifetime value models: predictive and historical.

• Predictive CLV models use current data to forecast future metrics. They can be used to predict how much each customer will spend over a specific period or throughout the entire relationship.

• Historical CLV models use past data to calculate the total amount customers have spent over the entire duration of the relationship. Historical models are great for understanding your current metrics, but they are less accurate at predicting the future than predictive CLV models.

Whether a predictive or historical approach is right for you as a CLV calculation model will depend on your business data.

Historical Customer Lifetime Value Approach

There are two models for calculating a historical customer lifetime value: the aggregated model and the cohort model. Both of these models are simple to calculate, but they have a certain drawback.

The main drawback of historical models is that they are based on the assumption that all new customers and their spending align with the average spending of customers in the past, which is not always true and can lead to misleading conclusions.

Aggregate Model 

The aggregated model is the oldest, simplest, and most common method for calculating CLV. It uses constant average metrics for spending and customer churn to determine a single CLV metric for all customers.

Although this model is the most widely used in calculations, it is simplified and therefore has several drawbacks. It does not account for differences between customers. This can lead to less accurate CLV forecasts, as it does not take into account differences between customer groups, such as seasonal buyers or high-spending customers, which can significantly impact the average cost per customer.

Cohort Model

The cohort model is similar to the aggregate model but addresses its main drawback. As the name suggests, the cohort model divides customers into different cohorts or groups. It assumes that customers within each group have similar spending habits and behaviors. The main concern with this model is how to effectively group customers. The simplest way is to group them by the start date of their relationship with your business, for example, by month, quarter, or year.

💡 Creating cohorts by month is the most popular approach, as it effectively accounts for seasonal peaks and troughs.

Predictive Customer Lifetime Value Approach

Predictive CLV models are based on current customer spending patterns and use regression analysis and machine learning to predict how much a customer will spend in the future. They also rely on historical data about past events, but use more sophisticated algorithms than simple historical models to forecast future performance.

Like the historical model, the predictive one also has two types of CLV forecasting models: a probabilistic model and a machine learning-based model. However, unlike historical models, both are quite complex in their calculations and require expertise in data analysis.

Probabilistic Models

The probabilistic models, which are also divided into several types, use the principles of probabilistic distribution to predict future CLV with more accuracy, including other CLV parameters, such as the number of future transactions or the future monetary value. There are 5 main probabilistic models:

• Pareto/NBD Model
• BG/NBD Model
• MBG/NBD Model
• BG/BB Model
• Gamma-Gamma Model

Of all the models listed, only two are the most widely used: BG/NBD and Gamma-Gamma.

Machine Learning Models

Machine learning (ML) models are currently the most effective tools for highly accurate predictions of future CLV. This is because these models use complex algorithms that are primarily capable of identifying patterns in your data and applying them to predict future customer behavior.

💡 ML models can also accurately determine RFM metrics (recency, frequency, and monetary value) for future transactions. These metrics can be very useful in marketing strategies, particularly in RFM segmentation. 

How to Calculate Customer Lifetime Value

The CLV formula measures the total value of a customer over their lifetime, which you can use to compare the cost of acquiring new customers with the revenue they produce over their entire relationship with your brand.

If you’re not sure how to calculate the lifetime value of a customer, you’re in the right place. We’ll walk you through the process of calculating customer lifetime value below.

Steps to Calculate CLV

To calculate customer lifetime value, follow these steps:

Step 1: Choose Your Preferred CLV Approach

As you may have understood from our explanation above, there are several formulas for calculating CLV. We’ll briefly review each one so you can choose the one that best suits your business.

• Historical models are much simpler to calculate, which is why companies most often use them to calculate CLV.

• Predictive CLV models require more expertise and more accurate data, obtaining which often necessitates the implementation of advanced analytical technologies.

Therefore, we’ll start with a simpler formula to quickly address the calculation. For simplicity, we’ll focus on how to calculate CLV using a historical aggregated model.

Step 2: Calculate the Initial Variables 

Before getting into the formula itself, let’s focus on the key variables needed to calculate CLV

Average Purchase Value (APV) or Average Order Value (AOV): This metric is calculated by dividing the total amount of all purchases over a specific period by the number of purchases during that period. APV shows the average value of each purchase made by a customer in your store.

Average Purchase Frequency (APFR) or simply Purchase Frequency (F): This number is calculated by dividing the total number of purchases over a specific period by the number of separate customers who made a purchase during that time. APFR shows the average frequency with which customers make purchases at your store.

Customer Value (CV): This metric is calculated by multiplying the average purchase value (APV) by the average purchase frequency (APFR). It shows the average value each individual customer brings to your business.

Average Customer Lifespan (ACL): This number is calculated by dividing the sum of all customers’ lifespans by the number of customers. Essentially, this is the average period of time a customer continues buying from your business. The ACL can also be calculated as one divided by the churn rate.

Gross Margin (GM): This number is shown as a percentage and represents the profit made before deductions. It’s calculated as total sales revenue minus the cost of goods sold divided by total sales revenue.

Churn Rate (CR): The churn rate is the percentage of customers who have stopped purchasing from your store within a given time period.

Step 3: Calculate CLV Using the CLV Formula

Now that you’ve got all the above variables calculated, you can use them in the CLV formulas.

Customer Lifetime Value Formula

There are several ways to calculate CLV and, therefore, several formulas you can use. Some consider cost factors, such as the Gross Margin, while some don’t, which causes differences in their final value. In this article, focusing on simplicity, we’ll describe the two simplest ones. We’ll also include a real-life example for each customer lifetime value calculation.

Formula 1: 

The simplest formula to calculate customer lifetime value is as follows:

Customer Lifetime Value = Customer Value × Average Customer Lifespan

💡 Calculating CLV may feel too complicated, given that there are many variables to take into account and many approaches you can use to calculate it. If you need help with calculating customer lifetime value for your business, you can turn to a customer lifetime value calculator.

This formula uses historical data to calculate an average monetary value that you can expect each customer to spend at your store throughout the given period.

Real-life example of using the formula:

Let’s assume that you’re the owner of an eCommerce store that sells coffee from all around the world. You already know that an average customer makes an order of around $24.40 at your store with each visit. You also know that your customers purchase from your store at an average frequency of 2 per month. In addition, your churn rate is 20%, which means your Average Customer Lifespan (ACL) is 5 years. So, let’s calculate your CLV:

APV = $24.40 per visit; APFR = 2 per month (24 times per year)

CV = APV * APFR = $24.40 * 2 = $48.80 per month ($585.60 per year)

CLV = CV * ACL = $48.80*12*5 = $2,928

So, an average customer will spend $2,928 at your store during their entire lifespan with you.

Formula 2: 

The second formula for calculating customer lifetime value is as follows:

CLV = Average Order Value × Purchase Frequency × Gross Margin × 1/Churn Rate

Unlike the first formula, this one considers the cost of goods sold. This calculation is more accurate for businesses that incur specified costs and want to find out the gross profit each customer brings. So, if you’re running an eCommerce store, this formula might be more suitable for you.

Real-life example: 

Suppose your store made $125,000 within a year. During that period, you had 750 unique customers who made 1,000 purchases in total.

APV = $125,000/1,000 = $125; APFR = 1,000/750 = 1.33

Let’s assume that your cost of goods sold for the entire year was $25,000 and your churn rate was 20%:

GM = ($125,000-$25,000)/$125,000 = 80%

CLV = 125*1.33*0.8*(1/0.2) = $665

Therefore, each individual customer is bringing $665 of gross profit, on average, during their lifespan with your business.

30 Best Strategies on How to Increase Customer Lifetime Value

Once you’ve calculated your own CLV using the formulas we’ve provided, you’ll likely want to compare it to the average CLV rates for eCommerce industries. However, regardless of whether your CLV is low or high, you’ll definitely be interested in strategies to improve it. The good news is that there are many ways to increase customer lifetime value. It’s not just about retaining customers, but also about getting them to spend more money with you. Essentially, there are three main ways to increase CLV:

• Increasing the average order value (AOV) in your store
• Increasing the purchase frequency in your store
• Improving customer retention and loyalty

Let’s take a closer look at the key strategies you can use to improve each of these factors.

Increase the Average Order Value

The average value of an order can be increased in two ways: 

• by encouraging visitors to buy more items in one order
• by persuading them to choose more expensive products.

Combining both is the strategy that will bring you the most benefits. Achieving either of these requires just a few simple shifts that you can quickly implement in your store.

Offer Free Delivery Above a Specific Order Value 

The best way to increase CLV is to increase the amount customers spend when they place an order. An easy way to do this is by offering free shipping above a certain amount of order value. This will lead customers to add more products to their carts just to qualify for free shipping.

Offer Promotions and Discounts for Big Purchases

Offering promo codes, discounts, or even gifts for big purchases will encourage your customers to place such orders in the future because they know an attractive reward will be waiting for them after!

Optimize Your Checkout Process 

The checkout is the most important stage in the buying process. Many customers abandon their purchases simply because the checkout process is too long, requires too many details, or doesn’t feel safe enough. Carefully consider the ordering process and optimize it effectively.

💡 Another thing you can do to encourage your customers to throw more items in their carts at the checkout stage is to have a wish list. You can prompt them to take a look at a specific item from their wish list before paying for their order. However, it’s important not to overdo it, so as not to complicate the checklist process.

Promote Upsells and Cross-sells 

Upselling and cross-selling are two effective strategies for eCommerce stores to increase their revenue. You can increase the value of their final order by encouraging your customer to buy a better, more expensive product instead of the one they’ve chosen. Similarly, you can encourage them to purchase one more item by cross-selling a cheaper product related to the one they’ve already put in their cart.

Settle Contribution Margin

Every business owner knows that without monitoring the contribution margin, a company can quickly end up with negative income if it focuses solely on average order value or CLV and fails to account for customer acquisition expenses. Strategies for increasing contribution margin consist of simple and obvious methods, but they are still worth considering if you want to reduce extraneous business expenses in the long run. Review the following points and analyze whether you can implement these methods to increase your margin:

• Negotiating lower production costs
• Raising prices
• Reducing shipping costs
• Reducing the number of returns
• Optimizing the product lineup, prioritizing higher-margin items

Intensify the Purchase Frequency

This is the most common way to increase CLV. If your customers buy more frequently, they’ll spend more money with you over time. To achieve this, you need to ensure that your product or service offers enough benefits, needs, or conveniences for them to come back again and again.

You also need to make it easy for them to do so — such as by offering a loyalty program or an app that makes it quick and simple for them to reorder when needed. This is especially useful if you have products that need to be replenished constantly. Here are a few ways to increase the purchase frequency:

Increasing Purchase Frequency Without Reducing Margins

In addition to marketing investments, there are other ways to increase customer purchase frequency that won’t significantly impact your margins. These tactics include:

• Optimizing the post-purchase experience to encourage customers to return. 
• Introducing and enhancing products that encourage regular replenishment purchases.
• Focusing on content and community engagement that keeps the brand visible.

Offer Discounts and Incentives for Frequent Purchases

Discounts and promo codes for frequent purchases are a great way to motivate your customers to buy from you again!

For example, if a customer buys at least three products in one order or makes an order of a substantial amount, they get a discount on their next purchase. This encourages them to come back again and again.

Use Loyalty or Membership Programs

Create programs that reward frequent buyers with extra rewards and benefits, such as free shipping that we mentioned earlier, or early access to new products. You can also create membership programs that offer exclusive discounts based on loyalty status levels. For example, a customer with a Silver membership level gets 10% off all future purchases. This is a great way to encourage customers to purchase from your shop more often!

Use Retargeting Campaigns 

Managing a brand, you have probably heard of retargeting campaigns. It’s very likely that you’re already implementing them in your business. Retargeting campaigns are based on past customer behavior and purchase data, which is why they’re so effective at showing the relevant products to the targeted customers.

Putting efforts into increasing CLV, you can leverage the power of these campaigns to encourage your customers to purchase from your store again.

Reduce Customer Acquisition Costs

To ensure consistent, large-scale customer acquisition, it is often necessary to adapt existing approaches and integrate new ones. Some types of marketing are characterized by an initial surge in acquisition that may eventually fade. When you notice this happening, you can switch to new acquisition channels or gradually reduce the budget for that type of marketing. Here are our tips on this topic, which can positively impact your CLV.

• Increasing conversion rates
• Focusing on targeting
• Investing in creative approaches
• Building organic channels without paid acquisition

Enhance Customer Retention

Reviewing our previous tips, you may have noticed that customer loyalty and retention go hand in hand with this metric. We’ve already provided some advice on strengthening loyalty and encouraging retention. To wrap up our main strategies for increasing your CLV, we’ll share a few more that focus specifically on loyalty and retention.

Offer Add-Ons and Extras 

Everyone likes surprises, and your clients are no exception. When you run an eCommerce business, surprising your customers can be as easy as offering add-ons and extras that they didn’t expect.

For example, if you sell clothing, offer gift wrapping or gift boxes, so your customers feel like they’re getting more benefits for their money when they buy from you.

This will make your customers feel more appreciated and increase the value of your products and your brand in their eyes.

Create a Community 

Brands are increasingly leveraging social media to build communities around their mission, values, and specific traits. Create a community on a social media platform like Instagram or TikTok, where people can interact with you and each other, share their opinions, and see the behind-the-scenes of your business.

This is a great way to build stronger relationships with your existing and future customers and gain their loyalty from the start.

Provide Professional Customer Support 

Improving your customer service can significantly impact your retention rates and customer loyalty. So, make it easier for customers to get support. Provide a convenient way for them to contact you, preferably via multiple channels (phone, email, social media, live chat), and, if possible, provide support 24/7.

💡 Train your customer service agents to be responsive and helpful, even if it’s an easy question or complaint that could be handled by the FAQ section or bot. In addition, make sure your service team knows how to answer questions and resolve problems quickly, so they don’t turn into bigger issues.

The Importance of Controlling Your CLV

Marketing experts recommend that you focus on discounts, unique promotions, and loyalty program optimization. These strategies work and are highly effective, but only if you’ve first analyzed all your brand metrics and determined whether your margin actually enables you to do so. Understanding your brand’s key metrics, such as contribution margin, CAC, MER, and others, will help you determine whether new investments will actually be cost-effective.

Final Thoughts

Staying on top of all the important metrics for your eCommerce can be challenging. However, you can narrow down the scope of your metrics by focusing on the most essential ones for your business. The customer lifetime value is one of the metrics that you shouldn’t ignore, as it can give you valuable insights into how your business is really doing. 

If you’re working on increasing your CLV, implementing the strategies mentioned in this guide can help you do that. To make sure you’re getting the best results, use A/B testing and adjust your efforts based on its results. 

If improving customer retention isn’t your forte and you’d rather rely on an expert, we’re here to help. Our retention marketing agency, Flowium, is an expert that guarantees effective growth in your customer lifetime value without exceeding your customer acquisition costs. Contact us and grow your revenue with our marketing experts.

Frequently Asked Questions