The lifetime value of a customer (LVC – sometimes written as CLV or LCV) is the money that a customer will pay to your business over the years that they do business with you. By calculating and understanding this simple number, you learn:
A simple way to calculate this is:
(Average Value of a Sale) X (Number of Repeat Transactions per Year) X (Average Retention Time in Years for a Typical Customer)
However, this formula can lead to dramatic over-/under-estimates for many local service businesses. Why? The average value of a sale and average retention time is often skewed for local businesses. More specifically, customers who come back for a 2nd, 3rd, 4th visit often spend more than on their first visit. In addition, many businesses see a significant drop off in retention between the first and second visits and subsequent visits. The results skew the averages resulting in wrong answers that could lead to very expensive mistakes for your company.
Lets assume a business identifies a group of 1,000 customers who first used their company many years ago. They then determined how many of these customers came back a 2nd, 3rd, … time. Using the chart below, 350 came back a 2nd time and 175 came back a 3rd time. They tracked the total sales from these visits and generated the following chart:
Using the simple formula above, the average customer visits the business 2 times and spends $215 each time resulting in a LVC of $421. However, the weighted average sale is actually $140 per visit ($243,798/1,745) resulting in a true LVC of $273.
Why does this difference matter? This business needs to spend less than $273 to acquire and service a customer (this example assumes a $0 cost of good sold) rather than $421. Sales and marketing expenses based on the $421 LVC are expensive mistakes.
Most businesses do not know the LVC for their business. These are 2 very common mistakes:
Using the math above, a modest improvement in the customer repeat rates from the 1st visit to 2nd visit from 35% to 45% increases LVC to over $300 and total value by over $40,000.