Customer Lifetime Value (CLV) is the total worth of a customer he/she will provide to a business over the whole period of their relationship with your business. It is an essential metric for business financial health as the acquisition of a new customer costs money (in advertising, marketing, offers, etc.).
Thus, the CLV must be higher than the cost of bringing in a new client for the business to survive. Also, it costs less to keep existing customers than it does to acquire new ones, so it is vital to retain your current customers while bringing in new ones. Therefore, it is important to keep track of your existing customers' satisfaction to prolong the time they continue to buy your services and products.
For example, let’s say a business has an annual marketing budget of $100,000. On average, the cost of acquisition of a new customer is $500. This means the company will acquire 200 new customers. The lifetime value of each newly acquired customer must be at least $500 to sustain the business. If your Customer Satisfaction does not maintain that level of CLV, you will be losing money. Besides, your current customers will be slowly leaving, creating the ‘leaky bucket’ effect. This is why, as research shows, about 60% of restaurants fail in the period of 3 years (of all new restaurants, 26% fail the first year, 20% within the second year, and 14% in the third year).
Knowing your business’s CLV helps to develop strategies to acquire new customers and retain existing ones while maintaining profit margins.
The other benefit of loyal and satisfied customers is that they serve as media for your business, recommending it to friends and families, which is free advertising. Not every customer will go as far as telling about your business to the family, but there will be a group of enthusiasts who may sometimes bring dozens of new customers to your business over the time of their relationship with your business.
Customer Lifetime Value (CLV) Using Customer Research Study
There are a number of Customer Lifetime Value calculations. Some of them take into consideration the decreasing value of a dollar received in the future versus the dollar spend on customer acquisition today.
We will omit the adjustment for the future value of money and will focus on a simplified formula. This formula can be used with the data collected in a simple survey among your current customers.
The formula for Customer Lifetime Value is:
CLV = Total Revenue From A Customer – Cost of acquisition of a customer – Customer retention cost
There are 3 factors that impact Total Revenue From A Customer:
How long the customer stays with your business.
How frequently the customer visits your business per year.
How much the customer (on average) spends on your products and services per visit.
Total Revenue From A Customer = Number of Years * Frequency
* Average Spend Per Visit
The above metrics for Total Revenue From A Customer can be obtained in a customer research survey. The questions can be worded like below. The wording and scales would need to be adjusted depending on the time your business is in the market, usual frequency, and spend at your business. This will depend on your category.
The Cost of Acquisition and Retention cannot be obtained through a survey. Customers don’t know this information. Thus, you have to use your marketing spend and calculate the amount per customer. However, the information collected from the survey can help you understand the number of new customers that you recently got. Then you may divide the marketing dollars you spent on acquiring new customers by the number of new customers from the study. Depending on when you had your marketing campaign, you can use the following data from Q1 – “This is my first visit,” “Less than a month,” and “2-3 months.”
The data in our survey is approximated as respondents don’t always remember how frequently they visit and the amount they usually spend. This data can also be obtained by looking at your bills and books. However, asking these questions in a survey has 2 benefits:
it provides a rough benchmark of how long a customer may stay with your business. By collecting the information from Q1, you can see what can be the longest time with your business. With some assumptions, you can then approximate how long do usually customers stay with you if you keep them satisfied.
most important: by segmenting the customers into high/medium/low spend groups you can then ask the questions to understand who are the high spenders, why they like your business, and what attracts them. This critical information can then be used to 1) make sure you keep them happy by keeping and enhancing the features they like; 2) track their satisfaction to make sure they will keep coming; 3) target people with similar demographics and needs with your advertising.
Segmenting Customers Based On Their Value For Your Business
According to the Pareto principle (also known as the 80/20 rule) in many businesses a little group of customers contributes to the majority of your business's revenue and profit. The proportions may vary, but in any case identifying this group of most loyal 'big spenders' is critical for you business.
Using the respondent data for Q2 and Q3, you need to assign a value for each respondent’s answers in the survey. To do that you need to assign a value to the answers like below. Then, you need to multiply value from Q2 by the value in Q3. For example, if a respondent said: “2-3 times a month” at Q2 and “$61-80” at Q3, the value of the customer is 2.5 * $70 = $175. This means that this customer on average spends $175 per month. After you do this for all respondents in the survey, you will have a value for each customer (except those with ‘Don’t Know’ answers).
Now you can rank the customers, segment them into top spenders, medium spenders, and low spenders. Cutting the data for top spenders and comparing it to medium and low spenders can provide a lot of insights for your business and help better target the most valuable customers.