Customer Lifetime Value and their effects on a Company
Customer lifetime value measures the amount of money a particular customer has spent in the company’s business by subscribing to their services and the money the company has invested in securing the customer’s interest in the company. The customer lifetime value is basically the return on the customer’s part as a response to the company’s efforts to keep them convinced of their own requirement of the company’s products and services.
The company invests in each customer in quite a number of ways. The Sales team of the company keeps the customer updated about all the services they can possibly avail, and how they will be beneficial to them. In order to land customers who bring a lot of value in terms of money to the company, it is imperative that the company keeps a track of the Customer lifetime value.
The data derived from such a calculation could help solve many analytical problems for the company. This provides the company with an idea of how much revenue they can expect from a business relationship with a client which lasts for a particular number of years. In simple terms, the customer lifetime value formula is Customer value*Average Customer Lifespan. The steps to lifetime value calculation are stated below.
Customer Lifetime Value Model
This model provides a basic guideline for all companies on how to calculate lifetime value of the customers.
- The average purchase value of a company for a year is estimated by dividing the total revenue collected by the number of purchases that took place.
- The rate of average purchase frequency is calculated by dividing the total number of purchases by the number of individual customers who subscribed to the company’s goods and services during that period of time, preferably for a year.
- Once the average purchase value and average purchase frequency rate are calculated, multiply both of them to get the customer value.
- Figure out the average customer lifespan by calculating the average number of years an individual customer continues the business relationship with the company by purchasing goods and services from them.
- Finally, to calculate the customer lifetime value of a particular customer of a company, multiply the customer value with the average customer lifespan in the company. This calculation will give the company an idea of the amount of revenue they can expect from an individual customer.
On the basis of customer lifetime value, the company takes decisions in the fields of marketing and sales. If a particular sales and marketing strategy gives a better output in the customer lifetime value estimation, the company sticks to that strategy. However, on comparing data, if they reach a conclusion that the customer lifetime value used to be higher than the present scenario, they are bound to take decisions as per the data. Hence, the estimation of customer lifetime value helps the company to take well-planned steps towards the realization of their company goals.
An example would help to understand the above lifetime value model better. If we are to consider the sales of Company X in a given year, we would first consider the average purchase value of a single customer. If the total revenue generated from the same customer in a year is $1, 00,000 and the number of purchases he made in a year equals 10000. The average purchase value amounts to $10 for him. Similar steps will be repeated for all other customers and an average will be calculated by adding all their purchase values and the number of customers taken into consideration.
Company X would also need an estimate of the number of customers they usually have all around the year. To calculate this, the total number of purchases made should be divided by the total number of customers. The frequency rate of average purchase say comes to 5.
The customer value will then be calculated by dividing the average purchase value by the average purchase frequency rate, which would amount to 10/5= 2.
The average customer lifespan will have to be calculated for X. This will be done taken into consideration all the previous customers and the number of years they have maintained a business relationship with the company. The number of years of the association will be divided by the number of customers, thus putting a number to the Average Customer Lifespan.
Finally, a customer’s lifetime value calculation will be made by multiplying the customer value (in this case, 2) and the average customer lifespan.
This data and estimation when analyzed will open ways for the company to be able to retain their customers longer, and strengthening the sales and marketing department of the company.