What is Customer Lifetime Value (CLV)
Customer Lifetime Value (CLV), the English term for "customer lifetime value" is an indicator of the activities of SaaS companies that allows them to define their health and development potential. It corresponds to the value generated by a customer throughout the duration of their relationship with the company. What is the importance of calculating CLV for a company, and how is it done?
Why you should track Customer Lifetime Value (CLV)
The Customer Lifetime Value (CLV) provides a quantified indication that puts the customer at the center of a company's development processes. It is therefore an essential SaaS metric for the strategic management, marketing, sales and business development departments of an organization. For marketing departments in particular, it is a real indicator of the direction to take in terms of the cost of customer loyalty or acquisition campaigns.
Customer Lifetime Value (CLV) is provided by indicating the value (in euros, dollars or other local currencies) corresponding to the average net profit of a customer throughout the duration of his relationship with the company. Its potential is unique, as it is an indicator that highlights the benefits that a customer brings not only when he or she arrives at the company, but during the entire relationship cycle. This global and long-term vision allows us to determine the most profitable and optimized segments of our customer base, as well as the quality of the customer experience they’re offered. As such, CLV is one of the KPIs to track for SaaS companies and is an important source of data on which to base decisions.
The benefits of CLV
Customer Lifetime Value (CLV) has many advantages:
- It allows you to develop your products and services in the right direction, taking into account the expectations of your customers. Taking CLV into account offers the opportunity to integrate customer feedback into the development process. Thanks to this measure, a company can freely assess the interest and profitability of modifying a small part of a product to satisfy a small number of customers.
- The calculation of the Customer Lifetime Value is used in the context of defining the ROI and the cost of acquiring a new customer. In this context, it is generally considered that marketing and communication campaign activities are not performing well if their cost to acquire a new customer exceeds the figure indicated by the CLV.
- Customer relations departments use CLV extensively to better understand how to satisfy their organization's most loyal customers. Retaining a customer is a less expensive strategic choice than acquiring a new customer. Moreover, a satisfied customer will be able to better recommend the company's products and services. Professionals also evaluate the Net Promoter Score (NPS) in parallel with the CLV, which allows them to understand to what extent a customer is likely to recommend their products or services to a friend or family member.
The Customer Lifetime Value (CLV) has many types of applications, mainly in marketing and customer acquisition strategy. Indeed, it is an easy-to-handle indicator that allows us to evaluate the average profit generated by a customer. Thus, it offers a broad vision of the company’s relationship with its audience: the average indicated by the CLV does not correspond to a single transaction, but rather to the entire life of the relationship between an individual and the company.
It is therefore an excellent indicator of the average degree of satisfaction of its customers, which is a data point that allows the company to prioritize its actions and investments in the long-term, to acquire customers according to their value. It is also a crucial figure for online companies specializing in e-commerce, which can predict customer demand in order to adjust their inventory and respond to fluctuating order volumes. Finally, it is a customer segmentation tool that offers viable strategies for retaining the most loyal customers.
Customer Lifetime Value (CLV) calculation
It is important to adopt the right approach to successfully calculate CLV. There are two ways to do this.
The first is to calculate the historical Customer Lifetime Value. This technique calculates what a customer has spent on the company's services and products. There are two ways to define the historical CLV of a customer:
- By using the ARPU (Average Revenue Per User). A very simple calculation - it consists of dividing the total sum of revenues generated by a customer by the total number of months of his relationship period and multiplying the result by 12.
- By performing a cohort analysis. With this solution, we get the monthly ARPU for all customers engaged for the first time with a company in a specific month.
The second method is used to calculate the predictive CLV. A real management tool, the predictive CLV is a technical metric. It is based on the analysis of the historical behavior of a customer or customers and the estimated retention cost in order to evaluate the lifetime and the revenue generated per customer. It is based on the use of AI and Machine Learning, and can only be implemented correctly by professionals of this field. It is a model that takes into account the trends and behaviors of customers throughout their relationship with the company.
The calculation of CLV is complex due to the large number of factors and variables that directly impact it. Please note that the formulas to obtain the Customer Lifetime Value (CLV) exclude:
- Sales, promotional and marketing costs invested to attract, convert and retain customers.
- The frequency of sales, purchases and orders made by customers.
- Prediction of future purchases and orders.
- Churn rate or retention rate.
- General operating costs of a facility and their frequency: rent payments, equipment purchases or invoices, for example.
- The discount rate, which impacts currency and varies the amount of a purchase.
Thus, companies calculating the CLV have the choice between the simple and the complete formula.
The simple formula provides an approximate figure, but it provides a business metric very quickly. It assumes that the investment over the life of the customer does not change. However, it requires a two-step process. In the first phase, we look for the LTV (Life Time Value) figure, which is obtained by multiplying the average value of a sale with the average number of transactions and the average retention time. Then, to obtain the CLV, the LTV figure is multiplied by its profit margin.
The full CLV formula is considered by professionals to be the best calculation to obtain the correct indicator. It aims to obtain the net cash flow, which is the figure corresponding to the revenues and costs directly associated with a client. This is relatively easy to obtain, if the annual turnover per customer is stable. This comprehensive approach therefore breaks down the annual costs and profits corresponding to a customer. To work it out, we need to know: the average gross margin per customer lifetime, the customer retention rate, and the discount rate and its frequency. The complete CLV is therefore obtained by multiplying the gross margin with the result we get from dividing the retention rate by the discount rate minus the attrition rate.
How to optimize your CLV
Companies that adopt a strategy to optimize their CLV (such as those in the CAC 40) can choose to create a loyalty program to encourage regular purchases. They can also use this data to improve their business, their customer relationship management, and extend their average life cycle. Showing you value them is very engaging for the consumer, so it significantly increases the longevity of the relationship period.
The CLV indicator can also allow targeting the most profitable customers in order to adopt a strategy of developing high sales (by abandoning average or low sales). Finally, CLV allows online companies to offer truly personal interfaces and an exceptional digital customer experience.
The applications and stakes of CLV calculation are considerable for companies whose activity and SaaS business is based on subscription purchases. It gives a clear, precise and quantified idea of their customer acquisition cost and retention rate. Nevertheless, the procedure to obtain it is technical, complex and time consuming - and errors in the calculations can have serious consequences in strategic decision making.
The CLV is by definition a financial projection, just like the calculation of Annual recurring revenue (ARR) or Monthly recurring revenue (MRR). It assumes that the company makes viable assumptions and knows how to make good use of the insights gained from its results. For example, companies that have been in existence for several years can handle a larger volume of data than younger companies.
Silvr offers support, guidance and advice in calculating metrics to our client companies that receive a loan. As part of their loans, our clients can connect directly to our analysis tools. They benefit from the automatic calculation of KPIs allowing their development.
In addition, our loans themselves are based on an analysis of a company's potential sales and include a CLV assessment. The income based financing method allows companies to tailor their monthly repayment amount to their own income. For example, in months when they have a large inflow of cash, they can generate a high repayment, while months with a small inflow of cash do not result in a payment obligation.
