How Does The Customer Lifetime Value Metric Works?

customer lifetime value metric

The Customer lifetime value metric – a business specific metric

The customer lifetime value metric (abbreviated as CLV) is the amount of money that flows from a customer to a company during their business relationship. The calculation of the customer lifetime value metric isn’t something that’s defined in a single formula like in the case of ROI or CPM since it depends heavily on the specific business model each business defines to itself. Thus, the CLV of a retail website will be different from the CLV of a SaaS company.

So how do such CLVs look like? You can find two examples below. I hope those examples will give you a basic idea of how it should work.

Calculating the Customer Lifetime Value Metric For a Site That Sells Hosting Plans

Let’s take for example one of the most popular services sold on the internet – a hosting plan. Most of these plans are sold for a yearly or bi-yearly subscriptions and the more the customer is engaged with his/her website there’s a high likelihood that he/she will keep on paying for at least 3 years.

To make things more simple let’s assume the owner of the site doesn’t allow to upgrade from one plan to another and that there is no refund policy available. Let’s also assume that he has only one hosting plan & one renewal plan. In addition let’s that no taxes are involved in the transaction. This, of course is not something that doesn’t happen in real life, but will make the calculations more simple.

So in order to calculate the customer lifetime value we’ll need the following parameters:

a) The average revenue that flows in to the company out of each new hosting plan the customer bought.

b) The average revenue that flows in to the company out of each renewal plan the customer bought.

Now let’s assume that the cost of a hosting plan is $3.95 per month and it’s sold for a yearly payment. Hence the yearly revenue that the company gets from a customer is $47.4.

Furthermore, our customer is happy with our service, and so for the following 3 years he/she paid a renewal cost which is $4 per month. Thus the revenue from the customer’s renewal will be

$4 * 12 * 3 = $48 * 3 = $144.

So when we add all of the revenue from this customer during his/her relationship with our company has we get a customer lifetime value metric of $47.4+$144 = $191.4.

In The E-Commerce World the Customer Lifetime Value Metric is More Complicated

E-Commerce depends on selling a versatile array of products with different pricing & different customer habits along the seasons. In most cases the customer doesn’t pay in advance & is free to purchase according to his needs.

Therefore, the overall customers’ LTV (lifetime value) metric is compound out of sales of many kind of products which are offered in the e-commerce website.

Again, for the sake of simplicity let’s assume our e-commerce site is an online hardware store & that there are four types of buyers. The first buyer orders 10 screws each month for $5, the second buyer orders 2 bottles of glue for $20 every three months, the third buyer orders 5 pounds of cement for $40 each month and the fourth buyer orders 9” of garage door bottom replacement vinyl insert for $10 each month.

Now let’s calculate the CLV for this hardware store’ customers:

Average Monthly Sale\quad =\quad $5+\quad \frac { $20 }{ 4 } +$40+$10=$60

If an average customer ceases to buy from our hardware store after one year then the CLTV will be calculated in terms of 12 months & thus the customer lifetime value metric is:

CLV = 12 month * $60 = $720

The Real World is By Far More Complicated

When dealing with the customer lifetime value calculation you have to be precise. Don’t neglect any kind of revenue you had in order to be able to estimate how much more money you have to invest in getting more paying customers.

On the other hand remember that as positive as a metric it can be, the customer lifetime value metric is not a profitability metric and as such you cannot rely on when you are looking for further business optimisation.

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