Customer acquisition is far more expensive for a business than servicing existing customers. The costs of marketing to people, running digital marketing campaigns, and selling to new business opportunities are astronomical. So, it should come as little surprise that many companies are looking at how to understand better and increase their customer lifetime value to maximize revenue over their average customer lifespan.
Understanding the drivers that impact customer lifetime value is complex. The customer journey involves the sales and marketing function, obviously. Still, customer loyalty is shaped by how well a customer is treated by those engaged in other customer touchpoints: the help desk, the field engineers, or the finance team, for example.
Being able to influence and predict customer behavior over the life of a relationship is key to understanding how to maximize customer profitability and the continued success of the broader business. It shows the way forward to helping how to convert new customers into repeat customers.
In this article, we'll explore how to calculate customer lifetime value and analyze in detail why it matters to a business. We also explore several approaches you can take to maximize your customer lifetime value.
Calculating Customer Lifetime Value
Calculating your customer lifetime value is the vital first step in developing new initiatives - it provides the baseline for you to build on. The metric will depend on the average purchase value and the order frequency. There are several ways to calculate customer lifetime value.
The most straightforward is taking the average order value, multiplying it by the average number of orders per year, and multiplying that by the average customer retention period.
This approach works fine if you have access to plenty of historical customer purchasing data. An alternative is to take the average customer order value and multiply it by the number of orders they place. This will work well if you need to get a sense of your customer lifetime value in a newer business.
Whichever way you calculate it, it gives you a baseline to build from. It should be one of the metrics you use as you develop your customer retention plan.
Why Is Customer Lifetime Value So Important?
Defining your current customer lifetime value metrics matters because it places the value of your relationships with existing customers and new customers at the core of your business. It helps managers of the various functions understand better how the business value their teams create can be repurposed to increase customer lifetime value. It helps senior managers better understand how best to allocate investment in the business, and for the CEO, it's one of the ways to help make sure “all compasses point north.”
Understanding it helps in several ways:
It Influences the Bottom Line
Given the scale of customer acquisition costs, it makes economic sense to find ways to maximize customer lifetime value. These costs come in many forms. Clearly, you have the upfront marketing costs of finding and persuading people to become new customers. Sales teams are expensive. Customer onboarding costs can be high, especially if training or services are involved. Loyal customers, in contrast, are less in need of these costly services. Instead, they'll look more to you more often to help them meet their needs. The best part is that your brand loyalty should increase over the customer lifetime, as they consider alternatives to you less frequently. More revenues from loyal customers, added to reduced customer acquisition costs, clearly increase profit margins.
It Demonstrates a Predictable Cash Flow
Cash flow is the lifeblood of any company and solves many of its problems. An increasing customer lifetime value is a good predictor of a healthy cash flow position for the business. Investors and shareholders look at cash flow as one of the vital signs of a business with growth potential, and it has a significant bearing on company valuations.
It Enables You to Gain More of your Target Consumers
Understanding your customer lifetime value and, crucially, what factors influence it can provide valuable insight into what shapes your customers' preferences. It highlights what factors drive customer satisfaction and how you can influence customer loyalty, for example. You can apply this valuable insight to help develop new products and services and enhance your existing offerings. It'll guide the way on how best to strengthen your brand loyalty and your brand profile.
It Allows You to Grow
Businesses are always seeking to develop further by creating new services and products, streamlining operational processes to reduce costs or better managing their risks. Having a sense of the predictive customer lifetime value allows managers to take more risks in further developing the business, safe in the knowledge that their loyal customers should provide a regular cash flow. Increasing customer lifetime value as a deliberate commercial strategy helps offer strategic options to the business, again enhancing a company's overall valuation.
It Helps Develop your Brand and Enhance your Customer Relationships
It's all too easy for a company to become so focused on its products and services that it forgets who matters in the relationship - the customer. Measuring and understanding customer lifetime value and finding ways to enhance it can provide the deep customer insights needed to improve the brand, the product, and customer relationships. This makes plain economic sense. Brand valuations are a significant driver for business valuations. Taking steps to boost customer lifetime value can create the return on investment that company owners crave.
Ways to Increase Customer Lifetime Value
The value of increasing the customer lifespan is obvious. What might be less obvious is how to best achieve this. Here are a few steps you might take to increase customer lifetime values.
Extend the Lifespan of Customer Relationships
Customer lifetime value is a function of the value you provide to them. Some of that'll depend on the nature, cost, and quality of the product or service you provide. In the eyes of the customer, enhancing your value proposition should increase the average customer lifespan and their value to you. If you sit on your laurels, watch your customer lifetime values fall.
Also, think about being easy to do business with. Being easy to work with has value to a customer, and it forms a significant element of the all-important customer journey. Ensure that all parts of the business understand the importance of customer lifetime value and how they can contribute to it, whether they work on the support desk or in the distribution or the finance function. Being easy to work with provides an informal but significant competitive advantage for you, as people are less likely to consider using alternatives to you.
Encourage More Frequent Orders
Another option to increase customer lifetime value is to encourage more frequent orders. This has the benefit for you in that those more frequent orders drive better cash flow compared to fewer, larger orders. Another advantage is that it provides an opportunity to cross-sell or up-sell new products and services to increase customer value. Maximizing opportunities for customer interaction is at the core of the business model used by many online stores and is hugely successful. Marketing automation platforms are ideal for engaging with customers and providing compelling events and opportunities to buy existing and new products from you, whether it be using discounts, giving them special offers, or by building customer loyalty programs.
Use Revenue Intelligence Capabilities
Modern marketing automation platforms and CRM platforms, together with a host of business intelligence systems, provide practically unlimited data points for a business. This data is ready to give you fresh insights and new opportunities. However, in all likelihood, there'll be too much data for a sales and marketing team to process easily or quickly. This is where revenue intelligence capabilities become valuable. Revenue intelligence applications can process large sales and marketing data sets to identify trends and opportunities that can easily be missed. These platforms can mine the data set to compare the same period year-on-year to see what initiatives or measures yield the best results in increasing customer profitability. Maybe it'll be regular flash sales that drive better engagement, perhaps it’s a customer loyalty bonus, or maybe it will be a new product launch. These insights can be used to influence future purchases.
Segment your Customer Engagement
A positive customer experience depends on a company understanding and addressing the unique needs of an individual customer. Customer segmentation is the way to group customers based on their specific interests and needs. A positive customer journey is most likely if you can segment your communication and engagement with them, whether it be email, SMS, or social media. You can use the capabilities as the basis for a customer loyalty program focused on retaining customers. A particular customer can receive information or promotions about their existing purchase or a complimentary product or service that they might find valuable. There's nothing more frustrating for a valuable customer than receiving information from a supplier that’s of little interest to them. It plants the seed that their favored supplier might be taking them for granted, and you'll see your customer lifetime value metrics slip if you aren’t careful.
Create Products or Services that Complement your Existing Offerings
Another way to improve customer lifetime value is to develop a product or development strategy that builds on the existing, proven service or product. This offers you the benefit of generating additional customer revenue without investing as heavily in the marketing needed when acquiring customers. The classic examples are printer manufacturers making their own printer cartridges and paper or running shoe manufacturers developing their own sports apparel. However you approach this, base the enhancements on a solid understanding of the target customers' needs. Offer them a compelling roadmap for remaining a valuable customer, and they'll likely take it.
Use the Freemium Model
Some business models can utilize the freemium model as a route to achieving customer profitability fast. This approach has proven incredibly successful with the ecommerce business model, where a service is offered free to drive broad acceptance. Then, valuable additions are provided for an annual subscription. Examples of this model include businesses like LinkedIn and a host of online games. This model will feature a high customer acquisition cost, as the platform is popularized, but the customer data it acquires allows the business to develop offerings that'll build customer satisfaction, revenues, and future value.
Recognize your Top Customers
Your existing customers can be your greatest advocate and your most significant source of information about the changing needs of the markets you serve. Improving customer lifetime value is dependent on getting fresh insights into the needs of the market. Many companies create customer councils that provide insight and can sanity-check new ideas, products, and services. People enjoy giving advice, especially if it's positioned as giving them privileged access to new services or industry personalities. Other companies reward their top customers with access to special events, unique products, or access to developers or celebrities. However your company approaches this, think about the incentives that'll inspire greater brand loyalty amongst your top customers and those near the top.
Make Customer Service a Priority
We’ve already explored how everyone involved in customer engagement can make a difference in customer experience. The most successful companies build a customer service culture where customer experience is paramount across the board. While everyone expects the sales and marketing functions to focus on customer service, commitment to genuine customer service comes through when there's a problem with sorting out an invoice or fixing a service or product that doesn't work as it should. People don't always remember what companies have done for them, but they do remember how they made them feel. Focus on excellent customer service, go that extra mile, and you'll see new customers become repeat customers very quickly. Customers typically focus on solving problems rather than trying to save money. Act like you understand that, and your customer lifetime value metrics will steadily increase.
Putting Customer Lifetime Value to Work
Understanding and growing customer lifetime value is a potential gamechanger for any business. It encapsulates much of what you need to know about buyers’ behavior, helping you better understand their needs and interests and providing you a toolset to develop your business and its viability.
Varicent has worked with many customers to develop their customer lifetime value by applying powerful revenue intelligence capabilities that help show how customers buy products and services. The capabilities allow their sales and marketing teams to monitor opportunities and trends proactively to drive better customer engagement and better results. Learn more, or book your demo now.
