How to Calculate Customer Lifetime Value

Last updated: 02-14-2020

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How to Calculate Customer Lifetime Value

Customer lifetime value (CLTV) is one of the most important metrics to measure at any growing company. By measuring CLTV in relation to cost of customer acquisition (CAC), companies can measure how long it takes to recoup the investment required to earn a new customer -- such as the cost of sales and marketing.

If you want your business to acquire and retain highly valuable customers, then it's essential that your team learns what customer lifetime value is and how to calculate it.

CLTV tells companies how much revenue they can expect one customer to generate over the course of the business relationship. The longer a customer continues to purchase from a company, the greater their lifetime value becomes.

This is something that customer support and success teams have direct influence over during the customer's journey. Customer support reps and customer success managers play key roles in solving problems and offering recommendations that influence customers to stay loyal to a company -- or to churn.

Getting stuck with the math? We did too. So let's break it down step-by-step together. 

Using data from a Kissmetrics report, we can take Starbucks as an example for determining CLTV. Their report measures the weekly purchasing habits of five customers, then averages their total values together. By following the steps listed above, we can use this information to calculate the average lifetime value of a Starbucks customer.

First, we need to measure their average purchase value. According to Kissmetrics, the average Starbucks customer spends about $5.90 each visit. We can calculate this by averaging the money spent by a customer in each visit during the week. For example, if I went to Starbucks three times, and spent nine dollars total, my average purchase value would be three dollars.

Once we calculate the average purchase value for one customer, we can repeat the process for the other five. After that, add each average together, then divide that value by the number of customers surveyed (five) to get the average purchase value.

The next step to calculating CLTV is to measure the average purchase frequency rate. In the case of Starbucks, we need to know how many visits the average customer makes to one of their locations within a week. The average observed across the five customers in the report was found to be 4.2 visits. This makes our average purchase frequency rate 4.2.

Now that we know what the average customer spends and how many times they visit in a week, we can determine their customer value. To do this, we have to look at all five customers individually, and then multiply their average purchase value by their average purchase frequency rate. This lets us know how much revenue the customer is worth to Starbucks within the course of a week. Once we repeat this calculation for all five customers, we average their values together to get the average customer's value of $24.30.

While it's not specifically stated how Kissmetrics measured Starbucks' average customer lifetime span, it does list this value as 20 years. If we were to calculate Starbucks' average customer lifespan we would have to look at the number of years that each customer frequented Starbucks. Then we could average the values together to get 20 years. If you don't have 20 years to wait and verify that, one way to estimate customer lifespan is to divide 1 by your churn rate percentage.

Once we have determined the average customer value as well as the average customer lifespan, we can use this data to calculate CLTV. In this case, we first need to multiply the average customer value by 52. Since we were measuring customers on their weekly habits, we need to multiply their customer value by 52 to reflect an annual average. After that, multiply this number by the customer lifespan value (20) to get CLTV. For Starbucks customers, that value turns out to be $25,272 (52 x 24.30 x 20= 25,272).

Now that you know your customer lifetime value, how do you improve it? While there are a number of ways to gain revenue, customer satisfaction and customer retention are two key ways to increase your customer's CLTV.

Making your customers happier will usually result in them spending more money at your company. According to HubSpot Research, 55% of growing companies think it's "very important" to invest in customer service programs. If we look at companies with stagnant or decreasing revenue, only 29% said this investment was "very important." Companies that are actively geared towards their customer's success are experiencing more revenue because of increased customer satisfaction.

Acquiring a new customer can be a costly affair. In fact, an article published by Harvard Business Review, found that gaining a customer can cost anywhere between five and 25 times more than retaining an existing one. Additionally, a study conducted by Bain & Company found that a 5% increase in retention rate can lead to an increase in profit between 25% to 95%. This makes it imperative that your business identifies and nurtures the most valuable customers that interact with your company. By doing so, you'll gain more total revenue resulting in an increase in customer lifetime value.

Next, read our guide to learn more about customer retention.

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