Customer lifetime value is one of the most important metrics an ecommerce merchant can keep tabs on, if not the most important. If you are not familiar with the term “customer lifetime value”, you may know it by one of its other names: CLV, lifetime value, LTV, or total customer value.
Regardless of how you refer to customer lifetime value, it’s very important to guaranteeing your ecommerce livelihood! The calculation allows you to determine what each acquired customer is worth to your store in the long run. This is a useful metric because it allows you to determine a few key things, like how much you can afford to spend on acquisition and what you should spend to retain each customer.
Traditional CLV Calculations Are Confusing
In theory, customer lifetime value should allow every ecommerce merchant to accurately assess if their marketing budgets are in check. However, this isn’t the case for most merchants.
The number one reason customer lifetime value is ignored is because it is confusing. A quick Google image search for “customer lifetime value calculations” will show you how complicated these formulas can be.
If you have a university math or finance degree, go ahead and take a stab at using those calculations. These complex calculations will give you an accurate value but they are overkill for most online stores. So if those formulas make your head spin (join the club), keep reading for an easier solution.
The Easy Way to Calculate Your CLV
Customer lifetime value calculations become much easier when you break them down into digestible chunks, and explain each step along the way. We will start with how to get the variables you need and then move to the individual components of the calculation.
All calculations can be done using weeks or months just be sure to adjust the equations to reflect the time period you are working with.
Variables You Need
We will start with the calculations you need before you look at CLV.
1. Average Order Value (AOV)
Most ecommerce platforms will calculate this for you. If yours doesn’t, simply use this simple equation. Just be sure that you are using a consistent period of time such as the past year. We will call this variable (AOV).
If you need to increase your average order value, we’ve got a number of tips that can help with that!
2. Purchase Frequency (f)
Traditionally, CLV calculations use purchases per week. This is an ambitious time frame for ecommerce merchants as many stores will only get one order per month or fewer from each customer. For our simplified ecommerce CLV calculation, let’s look at things annually!
Calculating purchase frequency is just as easy as measuring AOV. Be sure to use data from the same time period that you used for average order value, usually over a 1 year period. We’ll call this variable (f).
If this variable could use a boost, try our three tips to increase purchase frequency!
3. Customer Value (CV)
Before there is customer lifetime value, there is just customer value. This is the value of a customer’s average order multiplied by their purchase frequency. This gives you a value of a customer during a week, month, or year depending on the time frame you used to calculate average order value (AOV) and purchase frequency (f).
The Easy Way to Use the Customer Lifetime Value Formula
Now that we have the variables we need, we can look at how to discover the lifetime value of each customer! Here is the simplest way to calculate your store’s CLV:
Told you it was simple! Your customer lifetime value is your customer value multiplied by the average lifespan of a customer.
But you are a smart person and I am sure you have spotted the flaw here. What is your store’s average lifespan (t)? This unfortunately is not easy to nail down for stores that are new or only a few years old.
What is My Store’s Average Lifespan (t)?
The one true way to discover this is by looking at historical data. You look at your customer data and determine how many years, weeks, or months your average customer stays with you before going “dormant”, or stops purchasing.
You can do this by looking at your store’s average time between purchases. When you know how long a customer goes between purchases you can determine that anyone who goes more than two standard deviations past that is no longer a customer. The average time a customer goes before reaching that point is your store’s average lifespan (t).
For new stores, I would recommend looking at larger industry players to help determine benchmarks, or using a (t) value of 1-3 years. A (t) value of 1 allows you to look at the value in the immediate future, and a value of 3 is what analytics guru Avinash Kaushik uses in his calculations.
CLV Calculation Variants
The simple equation displayed above is well, simple. It ignores a few things that are very important, such as your store’s margin and customer variance.
1. CLV Including Margin
A customer lifetime value calculation becomes a lot more meaningful when you look at the margin you are going to see over the course of the shopper’s life. You might want to know the actual profit you will gain from each new customer, not just the revenue.
This calculation factors in margin to order to determine the profit you will see from a customer.
2. CLV by Segment
Calculating an aggregate CLV is great for making decisions on a store level, but segmentation is where you see its true value. There isn’t a new calculation here – instead, you just apply the formula to a specific segment of your customers.
There are endless possibilities for segmenting your ecommerce customers. Applying CLV to different segments allows you to see how profitable different types of customers are to your store. This allows you to see where you should be focusing your marketing efforts.
How you could segment:
Run a CLV formula on customers who were acquired from different channels. This allows you to see which channel is giving you the most value. You can then allocate more marketing budget or time to these more profitable channels.
A CLV analysis on customer location can reveal areas that are more profitable to your store. Say you discover that shoppers from Canada have a much higher CLV. You can then adjust your marketing to target more of these customers.
Take a look to see how certain customer actions are impacting CLV. Are customers who are registered for your loyalty program generating more value? How much more is a registered account worth over its life? These are questions you can answer when you segment by actions.
You Need to Calculate CLV
Even using a basic calculation for CLV puts you ahead of most merchants. Here at Smile.io we notice that only about 5% of merchants are actively calculating CLV to drive decisions.
You don’t need to make crazy calculations. You just need to be aware of the value a customer provides over the course of their life, and have an estimate of what that value is for your store. Being aware of your CLV allows you to make marketing decisions that drive long term success!
Below you can see our most recent ebook on calculating CLV and the benefits.