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Marketing 360® Blog

How to Calculate Customer Lifetime Value

Customer lifetime value is a vital metric to consider that will help you set a marketing budget and accurately target ROI goals.

Consider the following scenarios:

  1. You get a new client and sell an initial service with $500 in revenue.
  2. You get a new client, sell the initial service, then execute a strategy where you turn them into a repeat customer.  In the next 5 years, you sell ten different services for $5k in revenue.

Now, say your marketing investment to capture this lead was $800.

In the first scenario, you look like you’re taking a loss. Not too happy with marketing ROI.

However, in the second, the ROI is clearly favorable.

This is the difference made by calculating the lifetime value of customers, which gives an estimated-lifetime-value (ELV) number as a basis for your marketing investment.

When you lay it out, this seems fairly obvious.  Yet it’s a business calculation that many SMBs miss.  Short-sighted, they look for a one-to-one return on a marketing expenditure based on one transaction with a new customer.  This inflates cost-per-acquisition numbers in marketing ROI calculations.

The result is an under-investment in marketing.  Business owners put the brakes on a net loss of $300, losing the opportunity to win more business that will payout in the long-term.

To avoid this, you need to calculate the lifetime value of a customer so you have an estimate to work with.  Use this equation:

(Average value of a sale transaction) x (Number of recurring transactions) x (Average retention in months/years)

For example:

  • (Average transaction $500)
  • (Average recurrence twice a year, 2 x 500 = $1000)
  • (Average retention 5 years, 5 x 1000 = $5000)

You have to weigh the cost-per-acquisition of a customer against their estimated lifetime value.  As you make this calculation, you’ll need to get accurate data on your recurrence numbers, specifically what percentage of customers become repeat buyers.  It is ultimately an estimate, but it’s better than working off the fallacy that your marketing ROI is only based on the first transaction with a new customer.

Turn Customer Loyalty Into a Goal

Customer lifetime value calculations do more than help you accurately estimate your marketing investment.

They get you to focus on your customer retention strategy and long-term goals.

When you look at clients in the context of lifetime value, you create strategies that turn them into lifetime customers.  You develop customer service that creates relationships.  You always make things right, even if it means a short-term loss.  You know it will pay off later.

In today’s world of online information, reviews, and social media, loyalty is an important part of brand messaging.  If you have a large group of loyal customers, they become one of your best marketing tools by advocating your brand online.

The efforts you make to be useful and maintain your relationship with existing clients simultaneously works to attract new clients.  Which isn’t even part of the lifetime value calculation (but it’s worth considering).  How much is a customer worth when they not only become a repeat buyer but also become one of your most valuable referral sources?

Customer lifetime value is about more than just budgeting.  It’s an essential part of SMB business planning.

Investment and return are not always one-to-one.  Smart marketers know it’s even possible to take a loss at first (a loss leader), to gain a return later.  Trying to win every short-term battle can cost you the war, making the estimated lifetime of your business dubious.