How to Calculate Customer Lifetime Value

July 18, 2023
Sarah Stockdale

If you’ve been hanging around the startup marketing space for a hot sec— you might have heard the acronym CLTV. Now, we have a strict no acronyms rule at Growclass because the brotato class uses them to gate keep essential business information. So let's break down Customer Lifetime Value, learn how to calculate it, and integrate it into our growth strategies— shall we?

CLTV = Customer Lifetime Value

For anyone looking to build a growth strategy, understanding Customer Lifetime Value (LTV) is essential

It's more than just a marketing term—it's the key to understanding how profitable your customers are over time. Customer Lifetime Value helps you understand the long-term value of customers, telling you how much you should spend on getting new customers, and how much effort you should put into keeping the current ones.

So let’s get into how you can calculate your Customer Lifetime Value, and how to use it. Grab a hot chai, and let’s get into it.

What's this Customer Lifetime Value? 

Picture Customer Lifetime Value as your treasure chest. It's the total net profit your business can reliably bring in from a single customer over the duration of their relationship with your company. It's essentially the sum total of all the gold coins (profits) you'll earn from a customer, from their first spend to their last.

Why Should I Care about Customer Lifetime Value? 

Understanding Customer Lifetime Value isn't just about knowing another acronym. Here's why it's important:

1. It helps you figure out how much you can sensibly spend to attract new customers, or your Customer Acquisition Cost (CAC, in acronym land).

2. It gives you a health check on your relationships with customers—mainly, are they profitable in the long run or not?

3. It lets you craft your marketing strategies to match different groups of customers based on their Customer Lifetime Value.

4. It provides insights into customer retention—in other words, how good are you at keeping your customers around?

How Do I Calculate Customer Lifetime Value?

This might sound really complicated— but take my hand, we’ll get there together. 

Here's the formula:

Customer Lifetime Value (CLV) = Average Purchase Value (APV) x Purchase Frequency (PF) x Average Customer Lifespan (ACL)

Um, what?

Good point, let’s break it down.

1. Average Purchase Value (APV): This refers to the average amount of money that customers spend each time they make a purchase. To calculate this, you take your company's total revenue during a certain time period (say, a year) and divide it by the total number of purchases made during that same time period. 

For example, if your company made $100,000 in a year and there were 1,000 purchases, your Average Purchase Value would be $100 ($100,000 divided by 1,000).

2. Purchase Frequency (PF): This is how often a customer makes a purchase in a certain time period. You calculate this by taking the total number of purchases during that time period and dividing it by the number of unique customers who made those purchases. 

So, if there were 1,000 purchases in a year and 500 unique customers, your Purchase Frequency would be 2 (1,000 purchases divided by 500 customers).

3. Average Customer Lifespan (ACL): This is the average amount of time a customer continues to buy from your business. It can be a bit tricky to measure, especially for new businesses. However, it's generally calculated by determining the average number of years a customer continues making purchases from your business. 

For example, if you find that customers typically continue purchasing from your business for an average of 3 years, then your ACL is 3.

Now, let’s return to the scary seeming formula:

Customer Lifetime Value (CLV) = Average Purchase Value (APV) x Purchase Frequency (PF) x Average Customer Lifespan (ACL)

So, using the examples above, if your APV is $100, your PF is 2, and your ACL is 3 years, your CLV would be $600 ($100 APV x 2 PF x 3 ACL).

This calculation provides a predicted revenue you can expect from a customer during their entire relationship with your company. Now you know, on average, a customer spends $600 with your business. Cool.

And you need to know this information to build a solid growth strategy— because your Customer Lifetime Value tells you how much you can spend to acquire a customer, and still make a profit.

But, Sarah, my business is only a year old— I don’t have these numbers. What do I do?

First, remember, none of this is going to be perfect for a new business, but there are a few things we can peek at to get a better idea of your Customer Lifetime Value.

1. Industry benchmarks: Dig around for studies or reports about businesses that are like yours. They'll give you a rough idea about how long customers stick around, how often they're likely to buy, and what they spend on average. These won't be your exact numbers, but they're at least a place to start.

2. Short-term data: Even though your business is still in its early days, you've probably got some useful nuggets of info about your customers. Things like how often they're buying, what they're spending, and how long they've been with you can offer some clues about your CLV. They're a bit like looking at the trailer instead of the whole movie, but they'll give you a sneak peek of what to expect.

3. Predictive Analysis: Once you start to gather a bit more data, you can consider using predictive analysis models. These tools look at patterns in your early data to guess what might happen in the future, helping you to guess your CLV.

4. Surveys and customer insights: I’m a broken record at this point, but talk to your customers. They won’t be able to tell you how long they plan to stick with you, and what they'll spend— but with well designed customer interviews, you should be able to understand if you’re solving a problem for them, and how often they’ll need to repurchase . This info can then hop into your CLV calculations.

These are all ways to take an educated guess at your CLV, but they won’t give you a full picture. But just being aware of this data, and focusing efforts on uncovering more ways to predict your profit per customer, you’ll be well ahead of most new business owners. Now go forth with more information about your customers, and build a solid growth strategy.

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