We have all heard the expressions “customer is king”, “customer is always right” and so many more versions of the same. Yes, a customer is important, the most important entity for any business to be successful. But, is every customer equally important for your business? Being able to answer this question in a fair manner and then implement the levels of engagement required for different customers is what makes or breaks businesses in today’s digital world. When it comes to the importance of customers, the most important ones are often those who provide a lifetime value higher than their cost of acquisition.
Marketing teams tend to make a number of hypothesis on the basis of the kind of product or service you are selling, the kind of customers who have been known to respond better to certain aspects of your offerings or maybe even just their gut feeling. However, the decision should be purely based on the data available to you about your customer behavior. This happens when you calculate the value that each customer can bring to you in its lifetime, or Customer Lifetime Value (CLV). Lets take a look at how to calculate Customer Lifetime Value.
Calculating Customer Lifetime Value or CLV
In order to calculate CLV, you need to look at the past interactions or behaviors of your customers. Following are the three parameters that you need to focus on when trying to calculate CLV –
- Average annual transactions per customer
- Average profit per transaction
- Average number of years that user stayed your customers
Once you have the data for all the above parameters, you can feed it into the formula below
CLV = Average annual transactions per customer X Average Profit per transaction X Average number of years that people stayed your customers
The above calculation will give you the overall CLV for your business. However, like I mentioned above, all customers aren’t the same. The next step is to calculate CLV for each individual marketing channel
Implementing engagement based on CLV
Once you have the CLV data, the next step is to identify the marketing channels that align with the CLV for your business. The first thing to do is to group your customer base depending on the channels through which they are coming to you. Once categorized, it is easier for you to calculate the CLV of each group of customers.
Let’s say you are using three different marketing channels for customer acquisition. On calculating the CLV of each of these channels, you find that the CLVs of the first group are lower than the CLV of your business, while CLV from the last channel is noticeably higher than the average value. This is where more of your marketing spend needs to be focused, with the most valuable customers coming in through the third channel.
Scaling your business through CLV
For any business to scale their marketing spend profitably, the most important set of data is the customer acquisition cost (CAC) and the customer lifetime value (CLV). To be precise, if the CLV of your business is higher than your CAC that means longer term, the profit you make from your customers is higher than their cost of acquisition which means you can scale marketing spends and expect higher profitability as you keep acquiring more customers.
Of course there are a number of factors which can affect your CLV basis of the kind of product or service you are selling, the kind of customers you are targeting and the efficiency of your business operations. For example, good CRM practices for re-engagement, good and prompt customer support, fast delivery etc are all factors that can ensure higher number of orders from the same customers resulting in higher CLV for the business. Points based loyalty programs are a common tool re-engagement tool used by many businesses to increase their CLV.
Once you have identified the customers that provide higher CLV, the next step is to decide on the engagement practices for those customers. In today’s day and age, with the competition being fierce in every sector, and each of your competitors ready to bite into your market share, it is important that you have effective strategies in place when it comes to engaging with customers with a high CLV.