How to calculate Customer Lifetime Value in Marketing - YouTube

What's up y'all, this is Scott Davis and my goal today is to make calculating customer

lifetime value accessible and maybe even enjoyable

for you.

I'll refer to customer lifetime value by its abbreviation CLV throughout this video.

Let's dig in.

First, why is CLV important?

CLV gets at the heart of marketing's objective to attract and keep profitable customers.

You need to understand CLV to put together effective

marketing plans and make strategic decisions.

How much money are you going to allocate to attract new customers and generate leads?

Attracting new customers might cost 3 or 4 times as much as retaining existing ones.

CLV will help you understand what kind of return to

expect on today's investments in customer acquisition and retention.

How are you going to stop customers from defecting?

What aspects of customer attrition are controllable?

An average company loses 10 percent of its customers each year.

A better understanding of CLV will help you manage these dynamics.

Think of managing customers as managing a leaky bucket.

Your customers are represented by water and the water already inside the bucket is your

customer base.

New customers added to the bucket increase your customer base.

Ah, But there's also a hole near the bottom of the bucket and the water leaking out represents

lost customers.

So in order to grow, your business needs to increase the flow into the bucket by acquiring

new customers or decrease the customer outflow

by retaining your existing customers, or both.

It's also important to note that not all customers are profitable.

Have you heard of the eighty twenty rule?

Eighty percent of company profits come from twenty percent of its customers.

Given our fight against the leaky bucket and mixed profitability amongst customers, we

need a better understanding of customer profitability

in the long term.

Enter, customer lifetime value.

CLV is calculated a number of different ways, but let's focus on the common features.

We start with the top line, the company's expected revenues or sales in dollars over

the customer's lifetime.

We are interested in profit, so we also need to subtract the expected costs including

acquisition, sales, and service costs for the customer.

Have you ever watched the TV show Shark Tank?

Notice that the investor's financial questions usually relate to the variables used in computing

CLV.

It's not easy, but you can do it.

Here comes some math.

Let's start with the most basic formula for CLV.

CLV = the annual profit contribution per customer times the average number of years they

remain a customer... minus the initial cost of acquiring a customer... profit contribution

is the margin, or the amount of the sale that is

not eaten up by variable costs.

Other CLV formulas account for fixed costs and the time value

of money, but let's start slow.

Let's walk through an example with our basic formula.

Suppose the average Starbucks customer spends six dollars per visit and visits two hundred

times per year.

That is twelve hundred dollars in annual revenue per customer.

But the contribution margin is only three dollars

per transaction because of all the variable costs that

go into making a cup of coffee.

So the annual profit contribution per customer is six hundred dollars.

We multiply the six hundred dollars times the average number of

years someone remains a customer at Starbucks.

Suppose it is twenty years.

Now have six hundred times twenty for twelve thousand bucks.

But it costs money to acquire new customers, say five thousand dollars on

average per customer for Starbucks.

We subtract that from our twelve thousand to arrive at

a seven thousand dollar customer lifetime value.

This number is going to help us figure out how much to pay to acquire and retain new

customers.

Beyond that, we can see how important it is to sell more to our existing customers.

Can we push the six dollars per transaction higher?

Can we stretch twenty years of loyalty to twenty five?

How much will that cut into our contribution margin?

We could also take a more nuanced view and look at the impact of low and high profit

customers.

Did you know that different methods for attracting customers have different CLVs?

For example, Acquiring customers through deep discounting can substantially reduce CLV.

You need to be thinking about how much potential your new customers have to become loyal

to your business.

Understanding CLV will help you set and evaluate your pricing and promotion

strategies.

This concludes our first look at Customer Lifetime Value.

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Thank you.