Customer Lifetime Value (CLV): Definition, Calculation & Uses

Customer Lifetime Value (CLV): Definition, Calculation & Uses
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  • 0:02 What Is Customer…
  • 1:12 Calculating CLV
  • 3:24 CLV & Loyalty Programs
  • 4:46 Lesson Summary
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Lesson Transcript
Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and is currently working on his PhD in Higher Education Administration.

Customer lifetime value (CLV) is a marketing metric used to see how valuable repeat customers are to your business. In this lesson, we'll define CLV, learn how to calculate it, and discuss how it could influence your customer loyalty program.

What Is Customer Lifetime Value?

Every business has customers, and each customer has a lifetime with that business. Depending on the business, that lifetime could vary greatly. For example, a mortgage company will likely have few repeat customers, and the repeat customers they do have may only need their services once every ten years or less. On the other extreme, a grocery store may expect a loyal customer to be in twice a week, every week, as long as they live in that area. So, these two businesses approach repeat customers and customer loyalty very differently.

Perhaps the mortgage lender doesn't even acknowledge repeat customers, since even the low cost of just sending a postcard may be too much to pay to find that one customer who will get that card, and think, 'Yes, it is time I buy a new house.' On the flip side, the grocer would be incentivized to make sure they keep attracting their frequent customers. The question for the grocer, however, is how much should they be willing to pay in advertising or customer loyalty plans to keep those customers? This is what customer lifetime value, or CLV, helps a business identify.

Calculating CLV

The equation for CLV isn't that complicated, but getting good information to plug into the equation can be. The equation is simply:

CLV = (Average value of a sale) * (Number of repeat transactions in months) * (Average retention per customer in months)

The most difficult thing about this equation is getting good information. For example, it's easy to calculate the average cost of a sale because that's just what the customer spends. But 'value' in this equation means 'profit.' Profit can be more difficult to identify than the cost of a sale. That's why many businesses with frequent repeat customers will use loyalty programs that can identify the customer, so they can get precise CLV calculations for specific customers.

Take your local grocer, for example. The store offers a loyalty card that gives you a discount, and like any smart consumer, you sign up. After six months, your grocer looks at your activity and sees that you visit six times per month and spend, on average, about $100 per visit. Now, is the $100 the value of transaction? Not really. The value they realize is their profit, so they can figure this exactly based on what you buy. We are going to say they have a 10% profit margin, so each $100 purchase makes them $10. That gives the first two bits of information needed to calculate CLV.

The last thing needed is how long you will be a customer. This is obviously a guess, but with all the market research available, it is possible to make a good guess. They look at your address from your application, see that you own a home. From publicly available tax records, they know you bought that home a year ago. They also know most people in the area own a home for nine years, so you probably have eight left. Now, they have all the information they need.

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