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A step by-step guide to calculating customer lifetime value
- 1. A Step-by-step Guide to Calculating Customer Lifetime Value (CLV) Prepared by: Geoff Fripp, Adjunct Marketing Lecturer The University of Sydney http://www.clv-calculator.com/
- 2. What is Customer Lifetime Value? • Customer lifetime value is a measure of customer profitability over time • CLV can be defined as “a measure of a customer’s aggregate profit to the firm over the total time that the customer deals with the firm” • CLV is calculated as a single dollar number, which summarizes the net profit/loss position of the customer’s total relationship with the firm • It is calculated on per customer basis, but is more usually determined for an the average customer within a particular market segment • A firm will calculate multiple CLV’s for different customer segments
- 4. The Simple CLV Formula THE FORMULA Annual profit contribution per customer X Average number of years that they remain a customer Less the initial cost of customer acquisition WHAT INFORMATION DO WE NEED? 1. Initial cost of customer acquisition 2. Annual profit contribution per customer 3. Average customer retention rate
- 5. The CLV Calculation We start with this information We need to calculate this information
- 6. CLV Calculation: Step One Average Acquisition Cost 500 Average Customer Profit pa 1000 Customer Retention Rate 75% Customer Churn Rate 25% Average Lifetime in Years ??? Simple CLV ??? Churn rate is 1 – retention rate NOTE: Retention rate and churn (loss) rate always add to 100%
- 7. CLV Calculation: Step Two SIMPLE CLV Average Acquisition Cost 500 Average Customer Profit pa 1000 Customer Retention Rate 75% Customer Churn Rate 25% Average Lifetime in Years 4 Simple CLV ??? Average lifetime in years is 1 / churn rate That is, the number of times the churn rate goes into 100%
- 8. CLV Calculation: Step Three CLV is time/years X annual profit – acquisition cost SIMPLE CLV Average Acquisition Cost 500 Average Customer Profit pa 1000 Customer Retention Rate 75% Customer Churn Rate 25% Average Lifetime in Years 4 Simple CLV 3,500 EXAMPLE: 4 X $1,000 - $500
- 9. The Complete CLV Formula THE FORMULA Annual profit contribution per customer (for each year) X The customer retention rate (for each year) less The initial cost of customer acquisition With each year adjusted by an appropriate discount rate WHAT INFORMATION DO WE NEED? 1. Initial cost of customer acquisition 2. Annual revenue contribution per customer 3. Annual direct costs per customer 4. Annual customer retention rate 5. The discount rate to be used
- 10. Full CLV Calculation: Start COMPLETE CLV Year 0 1 2 3 4 5 Average Acquisition Cost 500 Average Customer Revenue 500 1,000 1,500 2,000 2,500 Average Customer Costs 300 600 900 1,200 1,500 Average Customer Profit ??? ??? ??? ??? ??? Customer Retention Rate 100% 60% 65% 70% 75% Cumulative Retention Rate ??? ??? ??? ??? ??? Likely Customer Profit ??? ??? ??? ??? ??? Discount Rate 1 1.10 ??? ??? ??? ??? CLV - per year ??? ??? ??? ??? ??? ??? Cumulative CLV ??? ??? ??? ??? ??? ??? We need to START with the figures in BLUE and we need to CALCULATE the figures in YELLOW Customer Lifetime Value will be in the bottom-right GOLD cell
- 11. Full CLV Calculation: Step One COMPLETE CLV Year 0 1 2 3 4 5 Average Acquisition Cost 500 Average Customer Revenue 500 1,000 1,500 2,000 2,500 Average Customer Costs 300 600 900 1,200 1,500 Average Customer Profit 200 400 600 800 1,000 Customer Retention Rate 100% 60% 65% 70% 75% Cumulative Retention Rate ??? ??? ??? ??? ??? Likely Customer Profit ??? ??? ??? ??? ??? Discount Rate 1 1.10 ??? ??? ??? ??? CLV - per year ??? ??? ??? ??? ??? ??? Cumulative CLV ??? ??? ??? ??? ??? ??? Average customer profit each year is simply average customer REVENUE less average customer COSTS
- 12. Full CLV Calculation: Step Two COMPLETE CLV Year 0 1 2 3 4 5 Average Acquisition Cost 500 Average Customer Revenue 500 1,000 1,500 2,000 2,500 Average Customer Costs 300 600 900 1,200 1,500 Average Customer Profit 200 400 600 800 1,000 Customer Retention Rate 100% 60% 65% 70% 75% Cumulative Retention Rate 100% 60% 39% 27% 20% Cumulative retention rate is the compounding effect of losing customers We start with 100% of customers and we keep 60% in year 2. In year 3 we Likely Customer Profit ??? ??? ??? ??? ??? Discount Rate 1 1.10 ??? ??? ??? ??? keep 65% of those remaining, which is 65% of the 60% = 39% CLV - per year ??? ??? ??? ??? ??? ??? Cumulative CLV ??? ??? ??? ??? ??? ??? Cumulative retention rate indicates the % probability of receiving the customer’s business (revenues and costs) in future years
- 13. Full CLV Calculation: Step Three COMPLETE CLV Year 0 1 2 3 4 5 Average Acquisition Cost 500 Average Customer Revenue 500 1,000 1,500 2,000 2,500 Average Customer Costs 300 600 900 1,200 1,500 Average Customer Profit 200 400 600 800 1,000 Customer Retention Rate 100% 60% 65% 70% 75% Cumulative Retention Rate 100% 60% 39% 27% 20% Likely Customer Profit 200 240 234 218 205 Discount Rate 1 1.10 ??? ??? ??? ??? CLV - per year ??? ??? ??? ??? ??? ??? Cumulative CLV ??? ??? ??? ??? ??? ??? Likely customer profit each year = Average Customer Profit (in row 3) X Cumulative Retention Rate (% probability of the customer still buying from our firm) Example for Year 3: $600 X 39% = $234
- 14. Full CLV Calculation: Step Four COMPLETE CLV Year 0 1 2 3 4 5 Average Acquisition Cost 500 Average Customer Revenue 500 1,000 1,500 2,000 2,500 Average Customer Costs 300 600 900 1,200 1,500 Average Customer Profit 200 400 600 800 1,000 Customer Retention Rate 100% 60% 65% 70% 75% Cumulative Retention Rate 100% 60% 39% 27% 20% Likely Customer Profit 200 240 234 218 205 Discount Rate 1 1.10 1.21 1.33 1.46 1.61 CLV - per year ??? ??? ??? ??? ??? ??? Cumulative CLV ??? ??? ??? ??? ??? ??? Future discount rates are compounded on a yearly basis In this case, the discount rate is 10% Future years are 1.1 X 1.1 = 1.21 X 1.1 = 1.33, and so on
- 15. Full CLV Calculation: Step Five COMPLETE CLV Year 0 1 2 3 4 5 Average Acquisition Cost 500 Average Customer Revenue 500 1,000 1,500 2,000 2,500 Average Customer Costs 300 600 900 1,200 1,500 Average Customer Profit 200 400 600 800 1,000 Customer Retention Rate 100% 60% 65% 70% 75% Cumulative Retention Rate 100% 60% 39% 27% 20% Likely Customer Profit 200 240 234 218 205 Discount Rate 1 1.10 1.21 1.33 1.46 1.61 CLV - per year -500 182 198 176 149 127 Cumulative CLV ??? ??? ??? ??? ??? ??? Contribution to CLV on a yearly basis is the “likely customer profit” divided by the discount rate For example, in year 3: profit = $234 / 1.33 = $176
- 16. Full CLV Calculation: Step Six COMPLETE CLV Year 0 1 2 3 4 5 Average Acquisition Cost 500 Average Customer Revenue 500 1,000 1,500 2,000 2,500 Average Customer Costs 300 600 900 1,200 1,500 Average Customer Profit 200 400 600 800 1,000 Customer Retention Rate 100% 60% 65% 70% 75% Cumulative Retention Rate 100% 60% 39% 27% 20% Likely Customer Profit 200 240 234 218 205 Discount Rate 1 1.10 1.21 1.33 1.46 1.61 CLV - per year -500 182 198 176 149 127 Cumulative CLV -500 -318 -120 56 205 332 Cumulative CLV is the running total of CLV per year Our key CLV figure is in the GOLD cell = $332
- 17. Full CLV Calculation: Outcomes COMPLETE CLV Year 0 1 2 3 4 5 Average Acquisition Cost 500 Average Customer Revenue 500 1,000 1,500 2,000 2,500 Average Customer Costs 300 600 900 1,200 1,500 Average Customer Profit 200 400 600 800 1,000 Customer Retention Rate 100% 60% 65% 70% 75% Cumulative Retention Rate 100% 60% 39% 27% 20% Likely Customer Profit 200 240 234 218 205 Discount Rate 1 1.10 1.21 1.33 1.46 1.61 CLV - per year -500 182 198 176 149 127 Cumulative CLV -500 -318 -120 56 205 332 CLV = $332 – which is a positive number – which is great This means that the $500 acquisition cost has generated good profits for the firm As a 10% discount rate has been used, the ROI on the marketing investment is MORE than a 10% return Payback on customer acquisition costs is delivered in Year 3
- 18. For lots more information… Please visit www.clv-calculator.com On this website you will find: • A free Excel spreadsheet for calculating CLV as shown in this presentation • Quick CLV calculators • Lots of CLV information and examples • Plus instructional videos http://www.clv-calculator.com/