What is customer lifetime value and why does it matter?

With multiple formulas to choose from, calculating CLV can be challenging enough. But then you still face the seemingly monumental task of improving this metric. How can you get customers to block out all the companies offering similar products and keep returning to yours? 

In this guide, we look at what customer lifetime value is, how to calculate it, and why it’s so important for your business. We also provide you with four actionable tips on how to improve CLV and retain customers. 

What is customer lifetime value?

Customer lifetime value is the revenue a company expects to earn from a single customer over the duration of their relationship. Knowing this figure helps you gauge customer loyalty and make decisions on spending, like how much to invest in retaining a current customer.

Let’s look at an example: 

If a pet owner spends $50 on a bag of dog food at your ecommerce store once a month, they’ll spend $600 over the course of the year, and $6000 if they continue shopping with you throughout the following ten years of the canine’s life. This is their CLV. 

If CLV rates increase, customers are spending more at your store—a sign that customer retention and loyalty are also on the rise.

Customer lifetime value vs lifetime value

While many businesses use customer lifetime value (CLV or CLTV) and lifetime value (LTV) interchangeably, others see a slight distinction between the two: 

CLV is the amount of revenue a single customer generates throughout their relationship with a company. LTV is the amount the average customer generates with a company. Technically speaking, CLV provides a granular insight, while LTV provides an aggregate one.

That said, most companies use the terms CLV, LTV, and CLTV interchangeably, regardless of whether they’re making calculations on a company-wide, group, or individual level.

How to calculate customer lifetime value

Many customer lifetime value formulas exist to account for nuances in data. These formulas fall into two categories: historical and predictive models. 

Historical customer lifetime value model

Historical customer lifetime value formulas are based on past data. These are typically more straightforward, so they’re good for businesses that see predictable customer behavior patterns—like purchases every other month—or for quick calculations by marketing teams to brainstorm ideas for targeted campaigns.

Let’s look at an example. 

Say an upscale online boutique specializes in high-quality children’s clothing, where the average customer spends $150 on each visit (the AOV) and makes three purchases per year (the APF). 

The customer value in that period is 3 x 150, or $450, and the average customer lifespan at the store is seven years. 

The store’s CLV is $450 x 7, or $3150. 

Predictive customer lifetime value model

Of course, customer lifetime value calculations aren’t always easy because consumer behavior often changes over time.

The predictive customer lifetime value model considers historical customer data and predicts future purchases based on customers’ current buying patterns. It’s perfect if you want a more precise prediction for your software-as-a-service (SaaS) company or ecommerce store, like when you need to create a detailed budget for a specific campaign.

For example, say your online record store has 100 transactions per month with an average order value of $50, and an AGM of 40%, or 0.40. Your ACL is 17 months. 

(100 x 50) x 0.40 x 17 = $34,000

Then, dividing that figure by the number of customers making purchases in that timeframe—let’s say 210 people—the CLV is $161.90. 

How to benchmark customer lifetime value: CLV to CAC ratio

Customer lifetime value doesn’t mean much in a vacuum—you need context to make sense of it. If your store’s CLV is $161.90, you won’t have any idea whether that’s ‘good’ or ‘bad,’ stable or changing. 

One of the best ways to gain an understanding of what your CLV means is to look at it as a ratio to your customer acquisition costs (CAC). To determine your CAC, divide all of your marketing and sales costs in a given period by the number of new customers you acquire.

If your CLV is $161.90 and your CAC is $52, your ratio is 3.1 to 1. Then, compare your ratio to industry benchmarks. Generally, a CLV to CAC ratio of 3:1 or higher is ideal.

3 benefits of customer lifetime value 

With so many key performance indicators (KPIs) to follow in the ecommerce space, why do experts consider CLV one of the most important ones to track?

Customer lifetime value is the magical intersection between creating a profitable business and customer satisfaction and loyalty. A high CLV indicates that an existing customer is happy with your product and customer experience (CX) to the point where they are willing to keep returning for more.

Let’s take a closer look at three ways improving your customer lifetime value boosts profitability and CX:

1. Reduce customer acquisition costs (CAC) 

You’ve probably heard the saying, “It’s cheaper to retain a customer than acquire a new one.” While the statistics that go along with this expression vary, most experts agree that it’s true. Customer acquisition involves content and email marketing and advertising tactics like paid ads—and the costs add up fast. 

By improving your customer lifetime value, you boost your customer retention, reducing your CAC over time.

2. Inform strategy and spending

Determining customer lifetime value helps you strategize for future marketing investments. If you know that a customer’s CLV is $300, it doesn’t make sense to invest $300 in retaining that client through email campaigns, discount offers, and targeted ads. Instead, you need to create a plan to spend just enough to keep the customer engaged and satisfied while maintaining solid profit margins.

You can also use CLV when planning inventory and developing new product lines. Segment your customers by the highest CLV to see which products they prefer. Then, introduce related products they’ll also enjoy.

3. Improve customer loyalty 

Customer lifetime value goes hand in hand with loyalty. When one improves, so does the other. 

Specifically, tracking CLV helps you see how customer churn affects your bottom line. Then, you know exactly when to introduce churn management and customer retention strategies, improving your CX. Satisfied customers become more loyal to your brand and increase their spending over time.

4 tips to improve your ecommerce CLV

Increased customer lifetime value means more revenue for your business over time. But you can’t just hope to see that metric rise when you check your analytics. Here are four tips to actively improve CLV for your ecommerce shop:

1. Personalize the customer experience

Personalization helps customers feel valued and seen, increasing the odds that they’ll make additional purchases from you.

To personalize the overall customer experience, start by gathering data to get to know your customers—who they are, what they want, and why.

2. Add value with targeted emails and content

Once you gather data, use it to segment customers into groups. Create customer segments based on similarities like satisfaction levels from surveys, demographics, or interests. 

You can also create segments based on customer lifetime value itself. For example, if you find that your loyalty club members have twice the CLV of non-members, you may invest more into this segment by providing them with discount codes and special offers. To boost the CLV of one-time purchasers, send out informational emails, video tutorials, and content guides to help them better understand product features and introduce them to new offerings.

3. Provide omnichannel customer support

When you support shoppers on their favorite platforms throughout the customer journey, you create a sense of satisfaction and build trust.

For example, one customer might prefer one-to-one attention via direct messaging on Twitter, while another with a do-it-yourself mentality might want on-page frequently asked questions (FAQs) or a collection of videos to learn how to use the product.

By providing support and helpful content, shoppers will see your brand and product as having unique value, creating a sense of brand loyalty that improves their CLV.

4. Collect feedback (and make it count)

The key to creating happy customers—and boosting their lifetime value—is to get feedback on their experience and then make tweaks and adjustments to your website, product, service, or shipping. Responding to feedback shows you’re responsive and builds trust. 

Install a Hotjar Feedback widget on a product page to ask customers if they found the information they need, or launch a simple survey to ask them how they prefer to get support.

Take a customer-centric approach to CLV

While it’s tempting to zero in on the value the customer provides to your business, it’s just as important to consider how you can add value to their experience.

Use product experience (PX) insights to get to know your customers, so you can develop personalized marketing approaches to keep customers returning for more—and increased CLV and lower costs will follow.