Customer Lifetime Value (CLV)
Customer lifetime value (CLV) is one of the most important subscription business metrics.
This is because CLV is used by subscription service providers to determine and measure the lifetime value of their customers. The profitability of subscription services generally increases as the length of the relationship with each customer increases. However, it is often the case that subscription services are only profitable for the provider once a certain contract duration has been reached (for example, due to marginal costs or customer acquisition costs).
The longer a customer subscribes to a provider’s services, the higher the customer’s lifetime value for the company – which in turn increases the customer/service profitability ratio.
Companies have a fundamental interest in retaining customers and their products and services for as long as possible and in encouraging them to make new transactions (renewals, upgrades, complementary purchases, etc.).
Subscription-based business relationships are the ideal tool to positively increase the customer lifetime value of your customer-vendor relationship in the long term.
The mathematical equation for calculating the CLV
What is CLV (customer lifetime value)?
The CLV is therefore used to determine the profitability of a product or company in an interdisciplinary manner and over a longer period of time.
CLV and Subscription Economy
Subscription business models are very powerful in terms of customer lifetime value because they create an environment where the default customer behavior is customer retention. The situation is quite different for non-subscription business models, where the default customer behavior is churn, even when CRM measures are taken into account.
“However, the underlying concepts that drive the subscription business can be complex at the start of a start-up. The pillar of any subscription business is therefore the CLV, i.e., the total profit that can be expected from a new customer over the course of his or her lifetime. The CLV thus drives the willingness to spend when acquiring customers. How much should I spend on my customer in total in product development, marketing, sales & Co.?
Determining customer value: How can I calculate CLV?
Customer lifetime value can be calculated in various ways. The complexity of the calculation depends on the content orientation. What exactly do I want to calculate and which departments do I want to take into account when determining the customer value? Basically, three important key figures must first be determined before the CLV can be calculated:
- What is the average order value?
- Where is the repurchase rate and where is the customer retention rate?
- What are the customer acquisition and retention costs?
The repurchase and customer retention rate is based either on an assumption or, in the best case, on empirical values. So, for example, if 75 out of 100 customers from last year are still their customers this year, the customer retention rate is 75 percent.
Note: The advantage of subscription models is that customers are already by definition repeat customers , often over twelve months. Therefore, an annual calculation of the repurchase rate in this case makes sense in terms of a realistic view.
Here is a example calculation based on the following assumptions:
Customer acquisition costs: 60 euros
Customer retention rate: 75 percent
Repurchase rate: 12 purchases per year
Contribution margin: 30 euros
First, the customer lifetime is calculated:
1 / (1 – 0,75) = 4 years
On the basis follows the calculation of the customer value based on his customer lifetime
(30 euros x 12 purchases) x 4 years – 60 euros acquisition costs = 1,380 euros.
Thus, the customer lifetime value is 1,380 euros.
However, a look at the company’s own tariff model shows how complex the calculation of customer value actually is. If, for example, there are upgrades to premium versions, higher rates, or in-app sales, another dimension must be taken into account in the CLV calculation.
Conclusion: customer lifetime value as a supporting forecasting tool.
Customer lifetime value is a per se meaningful metric for determining how much should be spent on acquisition and marketing for a customer. At the same time, the method also carries a predictive uncertainty. Start-ups in particular find it difficult to estimate the likely duration of the customer relationship, and even more the potential spend and the revenue. Companies with a history of several years have it easier here. And yet, especially in the subscription economy, the CLV should be seen as a supportive and dynamic forecasting tool that gets better and more accurate from month to month and from year to year.