Customer Lifetime Value Model: Maximizing the Math That Matters in Ecommerce

Ah, math. That class most of us tried to stay awake through, and a few people succeeded. Many people don’t love math and hoped that a calculator could solve their problems, but it isn’t always so, especially in the world of Ecommerce.

It’s time to get back in the habit of homework and review some quick math to understand our business, and how to improve it with perhaps the most important metric you’ll ever use: The Customer Lifetime Value (CLV). The CLV calculations for your business can look complicated, but they provide a clear snapshot of how well you’re doing and where you need to spend your money.

This piece will show you why it’s important, how you should calculate it, and what you can do to improve the results and boost your sales. Build up those margins today.

What Is Customer Lifetime Value?

Customer lifetime value is the total value that the average customer will contribute to your company over their entire relationship with you. This “lifetime” usually consists of 12 to 24 months for brands in the Ecommerce space. It helps you understand the overall viability of your business by looking at sales over a longer period of time, instead of just seasonal spikes.

In Ecommerce, this is getting a little easier to track and determine thanks to the sheer volume of customer information you can collect at the point of a sale. If you don’t have a robust CRM that can track individual customers, then it’s time to grab one. Look for a platform that’s smart enough to help identify CLV and even target customers who are in the middle of this life to boost your sales.

Targeting throughout is essential.

The more you can prolong the customer sales and increase CLV the better because it costs roughly five times as much to acquire a new customer as it does to keep an existing customer. (An older Harvard Business study says this can be as much as 25x for B2B companies). Plus, focusing on existing customers usually is an easier sale — you’ve got about a 60% to 70% chance to sell to an existing customer compared to 5% to 20% for a new customer.

Why Does CLV Matter?

Let’s keep things direct and honest: CLV is your single most important metric right now.

It is your best predictor of current success, lets you compare your success or fallings, and can help you determine if changes are having long-term impacts. These changes might be new products, different shipping partners, extra colors, and much more.

Determining your CLV can make it easier to understand if you’re not balanced for retention and new customer acquisition. It’ll teach you when a customer becomes profitable and can help you track CLV relative to the channels used to acquire them. It can give you a roadmap of where to spend and when to allocate more funds to either customer service or new items.

If your CLV is dropping, it can be a sign that you need to increase your service and outreach to existing customers. A growing CLV is likely a sign that your retention offers are successful and you might be able to shift a little more toward acquisition.

The right start to that understanding is learning the options for your customer lifetime value models, what they mean, and how to calculate them.

Calculating Two Customer Lifetime Value Models

The value of your customers requires data tracking, but thankfully the math is relatively easy. Even better, most Ecommerce platforms have some of the tools you need built-in to calculate CLV. We’ll review the formulas that are most important and the differences between the two most popular models, trying to keep things simple enough for anyone to calculate.

Historic CLV

The more straightforward customer lifetime value model is the historic CLV. This is a basic calculation of the adding up gross profit value per each individual customer for all of the transactions they have with you. Whenever possible, tie purchases to a piece of customer data such as name, credit card, address, or email.

In terms of the basic equation, here’s what you’re after for the historic CLV:

Historic CLV = (Purchase 1 + Purchase 2 + Purchase 3… + Purchase n) * AverageGrossMargin

The “n” is the total number of purchases, and the gross margin average is the margin for the average of your store’s orders. You can quickly calculate this CLV with Excel; it just needs total transaction information for the customer.

Calculate your margins based on as many elements that you can, from boxes and shipping to acquisition costs, returns, and replacements. You’re sticking with the average here because this model is simplified, and it’ll easily add hours to your calculations if you’re trying to find out the specific costs for every single order over the past couple of years.

Predictive CLV

Predictive data is all the rage, and it has a presence in Ecommerce here too. The Predictive CLV is a more complex equation designed to attempt an accurate CLV value for the past and future customers of your company. It’s a little more complicated:

Predictive CLV = [(AverageMonthlyTransactions * AverageOrderValue) * AverageCustomerLifespan]

It’s an innovative idea to use the lifespan in terms of months to create a more useful value because it’ll help create an understanding for how many customers you need to pay the bills at the end of each month.

Predictive CLV is a useful tool for figuring out the potential of each new customer, and it’ll help you figure out how many customers you need to have to keep things going. Determine the total number of customers you need to pay your bills (pad this with a few extras too). Hit that number, and then you can transition some of your acquisition spend toward increasing purchases from existing customers, growing the CLV and improving your business.

Advanced systems and tools can calculate a more accurate CLV relative to your products and business. When you’re ready for the big guns, find what works best and allows you to customize to your industry as well as customer demographics.

Finding a Deeper Understanding in CLV

Customer lifetime value models impact every aspect of the Ecommerce business. It points to the success or failure of your initial touch efforts and the interest you’re generating. CLV also demonstrations if you’re targeting the right people when you measure it relative to your acquisition costs.

You can evaluation both business and customers by judging your CLV. It also provides guidance on the loyalty of your existing customers — a good CRM will not only calculate CLV but also give you the timeframe in which they’re spending the most. In general, Ecommerce has a one- to two-year rule for customer devotion to your brand. Assessing CLV can let you know where you land in that timeframe.

Understanding how long it takes your customers to reach that max value can also help you determine how much to spend on your branding and awareness efforts.

Some businesses may want to compare their customer lifetime value models to their returns on ad spend (ROAS). The ROAS is a common metric that Ecommerce businesses use to see how much revenue they generate relative to each dollar spent on advertising. It’s a great ROI metric to start using if you’re new to the metrics or analytics space.

ROAS can provide some context for your customer acquisition strategy, and some companies may rely on it solely for their growth efforts, but this leaves a lot of opportunity on the table. A ROAS-only approach will have your business prioritize new acquisitions on ads — impressions and clicks above all else. This might not help you understand if you’re targeting the right people or if you’re making the most out of your existing customers.

Adding CLV to the mix can show your business’ overall profitability and point to the bigger picture of your overall success. It might give you a clear idea of when to shift some marketing dollars to email campaigns to existing customers by demonstrating expected profits from each customer.

Include Service in Your Customer Lifetime Value Models

We’ll get into some actual tips for increasing your CLV at the end of the article, but there’s a piece that’s important to start thinking about right now: customer service.

The better your service, the higher you can raise your CLV. This happens in multiple ways, which makes it important and useful for growing revenue. Improving your customer service can:

  • Reduce the number of returns you have
  • Improve your repeat sales numbers, because most people leave after bad service
  • Increase conversion rates and reduce abandoned shopping carts
  • Improve company reputation to help convert more
  • Happy customers spend more, especially when it’s a recurring or repeat purchase

Improving the customer service you deliver can increase the value of each sale as well as the number of sales you make per customer. That means delivering a better customer experience is a way to increase CLV dramatically, but it won’t be captured in your marketing reviews. In the same light, poor customer service can massively tank your CLV.

So, write yourself a note to look at ways to improve service outside of the advertising and other spending you’re considering growing your business.

6 Methods for Increasing the Customer Lifetime Value Model

Reward Sign-ups

Client onboarding can be a pain. It involves gathering data and greeting customers in a way that doesn’t interrupt or delay the sales process. The point of onboarding is to help client retention and increase the number of additional sales. Do everything you can to simplify the process — here’s a great guide to doing just that.

Beyond making it simple, it is smart to reward people for becoming customers with an account. This can be coupons for the next purchase, giving them free shipping right now, or anything else that makes sense for your business. Make the rewards easy too, and you’re set to generating a great customer experience that makes people want to shop with you again.

Newsletters

Newsletters are tried and true methods to improve customer lifetime value because they keep people thinking about your company and products. If you are providing useful information and making their lives easier, without a hard sell each time, then you can create a rapport where they look to you and your website to make their lives better. That’s a wonderful place for any brand to be.

Email Campaigns

Emails are a terrific way to help people get a new product, make an announcement, or share a coupon to get people back to your store. Keep emails simple and useful. Each email needs a purpose, and it should be something you’d want to get from a company you follow.

Looking for a few tips? Check out these subject lines that might improve your open rates.

Check Your Touchpoints

Increasing your CLV can happen when you increase the places you engage with your customers. This can be the email and newsletters above as well as social media, blogs, and more. You want a multichannel marketing approach. The more you reach out, the better you can move the needle.

Each platform and touchpoint need a marketing effort from any of your channels. Make the most of it by actively encouraging people to engage with each of these places.

Direct Cross-Sell and Upsells

You can make a more direct impact on CLV by working to improve each purchase. Look for opportunities to encourage customers to add extra items or pick up a related item. If you do it right, it’ll drive a nice little revenue boost. Match these extra items to a solution for a problem they face.

Remember, it’s generally easier to upsell than cross-sell.

Recurring Purchase Opportunities

One option for a specific upsell is a subscription model. This is a fantastic way to build CLV over time and get people locked into a purchase for the longer term. It’s why you see this so often with Ecommerce businesses, such as Loot Crates or the Dollar Shave Club.

Make Getting Orders Easier

The final piece of the puzzle is getting your order to the customer right and on time. This should be true whether you do your own packaging or hire an order fulfillment company with a delivery guarantee. It’s part of what we do to ensure that people have a great experience every time they open a package.

That’s a core goal of your business too. Every order should be right and lead to a smile. Enjoyment is a core part of boosting the CLV.

Always Review Your Customers

The final piece of understanding for your CLV models is that they will be different with different customers. Look at the patterns and changes in orders or habits to create segments for your customers. It makes personalizing all of the options above simpler, making them more effective and able to generate higher returns.

Try this guide to learn how to segmented buyer profiles to make the most of your store.

Author BIO

Jake Rheude is the Director of Marketing for Red Stag Fulfillment, an ecommerce fulfillment warehouse that was born out of ecommerce. He has years of experience in ecommerce and business development. In his free time, Jake enjoys reading about business and sharing his own experience with others.

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