How to Stop Worrying and Start Loving Customer Lifetime Value

You know that old saying about jamming all the eggs in one little basket? For many digital marketers, that basket is called “new customer acquisition.”

Don’t get us wrong: we love gaining new customers! But marketing strategies that end up monomaniacally focusing on customer acquisition are often lasered in on the new at the expense of customer retention. And that’s a big problem, because certain groups of loyal, repeat customers are actually responsible for generating the most profit for your brand.

If you’re not prioritizing their needs and investing in those relationships, you’re probably missing some significant low-hanging fruit that could make a big impact on the future of your business.

There’s more: building your marketing strategy around a customer lifetime value (CLV) model doesn’t just help you serve your most valuable customers, it helps you acquire better new customers because you know what those high-value customers look like. Many ecommerce challenges actually come down to two things: knowing who your best customers are and understanding how to efficiently acquire valuable new ones.

Let’s start with the basics.

What is customer lifetime value (CLV)?

Customer lifetime value (CLV) is a model that forecasts how much a customer is going to spend on your products across the entirety of the relationship between the brand and the customer, based on customer data your business already has.

CLV models can help you determine how much you should spend to acquire customers that are similar to your loyal consumer, what types of deals and products the highest CLV customers need/want, and even the content and creative your brand should be producing.

At the end of the day, CLV helps you tailor your marketing (and business) to your best customers, resulting in more efficiency and higher profitability. Peter Fader, professor at Wharton and co-founder of Theta Equity Partners, is probably the single most knowledgeable expert on customer valuation models out there. And he lays it out clearly: “All customers are not created equal. If we can really understand those differences and leverage them, we can make more money than if we just play it right down the middle and go after that average customer who might not even exist.”

What is the importance of customer lifetime value (CLV)?

Once CLV is calculated and you have identified which customers are most valuable to the business, that information informs where your marketing team should focus its efforts and budget. CLV should be the spine of your marketing strategy, from your media mix and retargeting windows, to any number of specific decisions you need to make as you send your marketing out into the world.

We recommend segmenting your customers into high-value, good-value, and low-value groups. For example, a stationary company found that their high-value group identified as calligraphers, their good-value group identified as writers, and their low-value group identified as students.

LTV helped the company:

• Segment the customer base more accurately and profitably
• Balance other KPIs such as acquisition cost, repeat purchase rate, churn rate, and more
• Evaluate and optimize marketing tools, tactics, and channels
• Target loyalty, retention, and reactivation programs towards the right customers
• Create lookalike audiences that mirrored the high-value group

High-value customers are more than 10x as valuable as low-value customers.

How do you calculate customer lifetime value (CLV)?

Don’t worry if math isn’t your favorite subject; this equation is pretty simple and calculating customer lifetime value doesn’t require a massive amount of data.

First we construct the RFM object, which summarizes each customer using 4 metrics from the transaction log. Here is a description of each metric:

• Frequency: the number of repeated transactions minus 1. This measures how often the customer buys.
• Recency: the number of months between the first and last transaction. A higher value here is better than a lower one and measures the time span a customer has been actively making transactions.
• Time as Customer: the number of months between the first transaction and today. If a customer shopped four months ago from today, they would have a low recency value compared to someone who was a first-time customer over a year ago.
• Monetary Value: the average spend per transaction, also known as Average Order Value (AOV).

The idea is that while customers make transactions they stay active and will follows rules that will predict their future spending. We fit these distributions with the RFM object and then use the estimated parameters to figure out the future spend of each customer. For each customer, we can calculate the likely number of future transactions, the probability the customer will still be active, and the average spend per transaction.

LTV= expected # of transactions X probability of being active X AOV (Average Order Value)

How can you increase CLV?

1. Use the three distinct lists of high-value, good-value, and low-value customers to drive decision-making. You want to create lookalike audiences to match your high-value customers, remarket to increase purchases from your good-value guys, and remove your low-value customers from targeting campaigns so you can spend that money on profitable customers.
2. Deploy a marketing strategy that doesn’t just focus on new customers, but existing ones as well. From re-engagement strategies to having a website that’s easy to navigate, you can make a lasting impression and build loyalty if you do this part right.
3. Show that you have nothing to hide. If you’re late on shipment, communicate that with your customer. If you’re making changes to a product, communicate that with your customer. Transparency is key and is something many marketers have learned throughout COVID-19.
4. Hello, rewards program! Customers love feeling appreciated and will stick with you if you create a rewards program that benefits both your brand and your customer.
5. Develop retention initiatives that increase sales. “Systematically rank all of your customer acquisition campaigns on the basis of their yield of loyal customers, and shift resources towards programs that attract the richest mix of loyal customers,” says Fred Reichheld, a fellow of Bain & Company and author of Loyalty Rules! How Today’s Leaders Build Lasting Relationships.
6. Upsell. Sparklane does a great job of upselling to new and existing customers. At checkout, they share an item they think you might like with the slogan: “throw them in the bag.” (For one second, I actually considered it.)
7. Stay in touch and always let your most loyal customers know how important they are to the success of your brand.

You don’t need to appeal to everyone, you need to appeal to the right customers. A famous example: “Nike took a stand with Colin Kaepernick and a lot of people said it was a huge political risk because you’re dividing the country in half and you’re going to alienate half the company. That’s not exactly the way it worked because they knew who their core customer is and they wanted to get more passion from their best customers,” says Anthony Choe, Provenance Founder.

To put it simply, investing more in retention than acquisition is how you continue to increase your CLV. Look to your customers for direction, and you’ll find that it does wonders for your brand and business.

Go deeper on customer lifetime value with our panel in Customer Behavior: Predictive Corporate Valuation & Strategic Direction, featuring Wharton Professor Peter Fader, Provenance Founder Anthony Choe, and Brentwood Associates Operating Partner & CMO Jay Sung.