Simple CLV Formula

 

There are two main approaches to calculating customer lifetime value.This article discusses the simple approach to calculating customer lifetime value – which is appropriate to use when customer profit contribution to each year are relatively flat. It is also a good idea to review the article on the full customer lifetime value formula, also available on this website.

The simple customer lifetime value formula

The simple customer lifetime value formula is:

Annual profit contribution per customer X

Average number of years that they remain a customer

Less the initial cost of customer acquisition

An example of the simple customer lifetime value formula

Let’s assume the following:

  • Profit generated by the customer each year = $1,000
  • Number of years that they are a customer of the brand = 5 years
  • Cost to acquire the customer = $2,000

The customer lifetime value of this customer would be:

$1,000 (annual profit from the customer) X

5 (number of years that they are a customer) less

$2,000 (acquisition cost) = $3,000 = CLV.

That is, $1,000 X 5 – $2,000 = $3,000.

A more detailed example of the simple CLV formula

Let’s look at the same formula to calculate customer lifetime value, the building a little bit more complexity by changing the initial assumptions as follows:

  • annual revenue per average customer is $2,000 per annum
  • product costs associated with the average customer’s purchases is $500 per year
  • the firm also spends $100 a year per customer to provide customer service
  • annual retention rate (loyalty rate) is 80%
  • average costs to acquire a new customer are $1,000

In this example, we have a similar challenge to the example above, but the information is not presented as neatly and we need to modify some of the above data to feed into the customer lifetime value formula.

Our first step here is to calculate the average annual profit per customer – which is determined by deducting the two sets of costs (product costs and service costs) from the annual revenue. In this case, it is $2000 – $500 – $100 = $1,400.

We have acquisition costs provided for us ($1,000), but unfortunately we do not have the average lifetime of the customer in years – we only have the annual retention rate. This will be a common situation in a workplace, as it is relatively easy from a customer database to calculate retention rates. So our challenge is now to convert a retention rate to the average number of years that the customer will deal with the firm.

There is another article on converting retention (loyalty) rates to an average customer lifetime period. However, it is quite easy to calculate the customer lifetime in years from a retention rate, as follows:

100% divided by (100% minus the annual retention rate)
OR (1 / 1- annual retention rate)

So in this example of an 80% loyalty rate, the average customer lifetime would be:

100% / (100% -80%) =
100% / 20% = 5 years average customer lifetime period

Now we have all the inputs into the simple customer lifetime value formula, we can then calculate CLV as:

CLV = $1,400 (profit) X 5 (years) – $1,000 (acquisition) = $6,000

Related Topics

Free Excel Templates to Calculate Customer Lifetime Value

Calculating Average Customer Lifetime (in years and months)