Identifying High-Value Customers
Choosing which customers to target is one of the most crucial decisions a business can make. Marketing budgets are limited and all marketing departments are tasked with attracting prospects who will turn out to be loyal, profitable, and easy to retain. The only real tool to measure the quality of a customer is the CLV as it gives granular insights into how valuable each one is. If the average CLV is low, that might be a cue for the business to adjust its marketing strategy accordingly.
Determining acquisition costs
Customer acquisition costs (CAC) along with CLV prove to be useful in determining how much leeway in business has in acquiring customers. Why? Because if the amount earned from a customer is dwarfed by the amount spent to acquire them, the business will suffer in the long–term.
Consider the example of a magazine subscription business where the cost to acquire a customer is $500 and the average subscription tenure is 5 years. If an annual subscription costs $1,000, then total revenue (as measured over 5 years) is $5,000. The business incurs additional costs to the tune of $50 per customer. In this case, the CLV of the customer is:
CLV = $5,000 – $500 – $50 = $4,450
In this example, the method for calculating CLV differs slightly from the formula mentioned previously. This is because of the nature of the subscription business, where each purchase is a recurring purchase and (in our case) the purchase value remains steady at $1,000. Furthermore, subscription businesses (especially those that operate digitally) generally have fixed costs of production that do not scale linearly with a concurrent rise in customers.
As a result, the original formula is tweaked to fit the business model to arrive at a reasonable estimate of the CLV. However, the fundamentals remain the same – measure revenue for as long as the customer transacts with the business, and subtract the costs associated with attracting and servicing them.
Sowing brand loyalty
Brand loyalty is usually a function of average purchase frequencies and average customer lifespan. When both of these figures go up, a customer is deemed to be loyal. This results in an increase in CLV, which then translates to better business outcomes.
Brand loyalty programs can help the company identify loyal customers and institute initiatives and rewards that can help retain these customers, thereby increasing their CLV in the long run. Building brand loyalty is a cornerstone of architecting delightful customer experiences and driving overall customer engagement.
Everything that a CLV enables a business to do, revolves around customer retention. The longer a business can retain its customers, the greater the prospects of it succeeding. Customer retention, colloquially referred to as the churn rate is calculated using the following formula:
The higher the retention rate, the better it is for the business. As a general rule of thumb, businesses usually aim to have a retention rate of 85%.