There are usually many metrics that show the current state of the business, monthly sales, unique visitors, etc., but unfortunately very few of them give us a broader picture of the health of the business. Very few give us a long-term vision of what we are doing.
This is where the customer's life value (or CLV, for short) comes in, since it is one of the few indicators that will indicate the current and future status of your business. CLV is a transcendental metric for all kinds of online stores that is often overlooked and provides relevant information to know which customers are worth retaining and which are not, in addition to understanding in a more structured way the contribution that each of them delivered to business at specific time intervals.
If we know the amount of money that each client will contribute to your online store, the CLV will let you know the amount of money to invest in the acquisition of each of them and thus obtain a positive margin at the end of the year. There are several benefits, and in this article "What is the Customer’s Life Value and why is it important for your online store" we will talk about the most important ones and also how to get a first approximation to this important metric.
There are many reasons for calculating CLV consistently
- The Customer’s Life Value is the key point to determine the clients that contribute more to the business and those that do not do so much. Thus, within this spectrum of people, you can create different activities to focus on different segments
- This will allow you to create a profile for your ideal customer, making easier for you to understand them and satisfy your needs in your online store
- If you are trying to obtain financing and you are very clear about the values of CLV (and they are positive), investors will see that you are focusing on the correct metrics and fully understand your business
- While there are many quite complex formulas to calculate it, there are also quite simple approaches to obtain a useful value for your company. Although in this article we will show a simple way to calculate it, the formulas of greater complexity have their raison d'être. Clients sometimes show unreasonable behaviors that are difficult to see in numbers, but for now, it is not necessary to make it more difficult than it has to be.
The information needed to calculate the CLV
The first thing you should do is segment your customer base to perform a CLV analysis for each specific segment. The behavior of your customers will be very different depending on various factors, so it would not make sense to put them all in the same bag.
So initially separate your customers by the following factors:
1) How recent was their last purchase
2) Frequency of purchase
3) Money spent
For the same period, say 1 year, assign a value of 1 to 3 for each of these variables and separate your clients into different categories, so instead of having a large group of 100 clients, for example, you will now have 3 well-defined groups, ordered from greater to lesser relevance for your business.
Now you have your different segments, calculate the CLV to determine which are the most valuable customers. To do so, we need 3 simple figures:
Average order amount
The average order amount shows the average amount of money that the customer spends each time they place an order in a defined period of time. To obtain this value, you need to find the total revenue for the segment you are analyzing and divide it by the total number of orders made by this segment. If you have a Jumpseller store you can easily download all the information in Microsoft Excel format to calculate the average value and the other indicators needed to calculate the CLV.
Average order amount = total sales / total number of orders
Frequency of orders
As the name says, this indicator gives the average amount of purchases made by each client for a specific segment and in a certain time interval (same as for the calculation above).
Frequency of orders = total of purchases made / total customers for this segment
The customer value is expressed in the monetary contribution he makes over a period of time. It is obtained simply by multiplying the 2 previous values, average order amount and frequency.
Customer value = average order amount x frequency of orders
Obtaining the customer's life value
We already have the customer value for your different segments, now to obtain the CLV you must simply multiply this customer value by the amount of time that this customer will be buying in your online store. This value is called Average Customer Life.
In many businesses it is easy to know the time that a client will be occupying your services because there is some kind of contract involved, but for most online stores there is no contractual bind that forces customers to buy.
If the store is new or has only been around for a short period of time, 1 or 2 years, you will not have the necessary data to know exactly what the average customer life is, but don’t worry, we can always estimate this value to obtain a more or less realistic result. If this is your case, it takes an average life of 3 years, which is used as a standard value in these cases.
Thus, CLV = Customer Value x Average Customer Life.
So, if your calculations yielded a Customer Value of $ 500/year, the CLV will be 500 x 3 = $1500
If you do this calculation for home customer segment you will know which are the most relevant for your business and how much you should spend to generate more customers like them. To calculate has been said!