How to calculate the lifetime value of a customer for your ecommerce
Calculating customer lifetime value (CLV) can be an excellent way to make predictions about the possibilities for growth that a particular client could bring to an ecommerce, but it is often neglected in companies’ digital marketing strategies. Its aim is to estimate how much value a client could generate for your business during the rest of their lives. There are two ways to calculate CLV, which we will look at in this text, letting you know the formulas, and discussing why these doing these sums is so important.
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What makes CLV so important is that it helps you predict how much a client will generate during their lifetime. It can have different aims, amongst which is finding out how much you should invest to gain a new client, a big help when it comes to determining your marketing budget. Have a look at these three reasons for not just estimating CLV rates, but also how to improve them.
Having a CLV figure is vital for helping focus your efforts on your business’ most profitable clients. This means gaining insight into which are the top demographics you need to reach through your marketing campaign. Obviously, knowing about CLV increases your competitiveness in relation to your competition.
Planning a marketing campaign focusing purely on people who will only buy your products once, rather than those who have the potential to be repeat business, is not ideal. The impact should be calculated in relation to the increase in customer lifetime value after the campaign is carried out. Only after comparing the numbers achieved by your marketing strategies with the previous CLV can you measure what you got right and what you got wrong.
Dividing up your buyers by their CLV could be a good way of improving the way you communicate with different types of clients. With this grouping, you also make it possible to identify the behavioural triggers which incentivise your clients to close a sale. Finding this out, it becomes easier to encourage people to buy, improving your results.
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There are two ways of calculating CLV: one based on history and the other predictive, which tries to predict the value of a client during their lifetime. The historical CLV calculation is useful to find out how much a specific client has already earned you. You should calculate the gross value of all their purchases up to a certain transaction by X, in which X is the value of their most recent purchase. Multiply this by your gross profit margin. In this way, you can find out how much the client has earned you over time.
CLV = (SUM OF ALL TRANSACTIONS)gross profit margin.
The second, and more important one, is the predictive calculation, which will help you to estimate a client’s potential. The simplest formula you can use for predicting potential CLV is multiplying the monthly transaction average (T) by the average transaction value (ATV). Then, this value should be multiplied by the gross profit margin (GPM), and the resulting number should be multiplied by the average life expectancy (ALE) of the consumer, calculated in months. As a formula, this becomes:
**CLV = ((TATV)GPM)ALE
A more detailed formula uses three different variables in the calculation. The first variable is the gross contribution margin times by the client’s life expectancy (GML), the second (R) is the rate of monthly retention, and the last is the rate of monthly discount (D) awarded by your business. In this, CLV is decided by the division of the retention rate by the sum of 1+D-R, which result is multiplied by the GML rate. However, no predictive model is totally correct, and every business has different requirements. Normally, the more complex a sum, the closer to reality the result will be.
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There is an automatic CLV calculator available online. This tool is definitely a good way of getting estimates, but you always should take the quirks of your business into account. As much as it can make your life easier, you should never trust it 100%. The calculator works with two obligatory values and one optional one: the average value of purchases and the rate of repeat purchases being values that you have to include, and the cost of client acquisition being something you can choose to leave out of the calculation.
Click on the link to go to the calculator.
CLV calculations should never be done only once, considering the constant changes in the market. CLV is a good indicator of your current and future profitability. To improve it, focusing on two aspects of your business can help: improving your repeat purchase rate, and increasing the value of each purchase. The more orders a client makes and the higher the average value of these purchases, the better your CLV will be.
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