Thorough Guide to Customer Lifetime Value

- E-Commerce

Ecommerce CVL: Magento Customer Lifetime Value.

Customer lifetime value estimation of business has long been abandoned by merchants until this year, when its commercial value has been reevaluated. The main reason of such a change lies in never-ceasing search for improving the effectiveness of online sells to meet the requirements of constantly growing market. Calculation of customer lifetime value is really handy for businesses of all kinds because it helps to concentrate more on the long-term future of your relationships with the customers and, as a result, on the long-term future of your company.

By defining customer lifetime value you primarily reveal how much net profit a customer will generate over the whole period of customer-merchant relationship. There are various types of mathematical representations of customer lifetime value calculation which differ in their complexity and businesses for which they can be applied. To get a better idea of this concept, we will provide you with a thorough guide through the wonderful world of customer lifetime value.

What is customer lifetime value

Customer Lifetime Value (CLV) is an estimated value of the net profit you can get from dealing with a particular customer in the future. The more precise definition describes CLV as the dollar value of a customer relationship which is based on the present value of the probable future cash flows from the customer relationship.

Knowing CLV in respect to your company helps to determine the limit of money you can spend to acquire new clients, so you’re likely to realize how much income you receive for advertising campaign in a particular case. By using CLV, you can also define the actual value of each customer and create a niche of those customers that suit you best.

Customer lifetime value is mainly useful for relationship-focused businesses, such as banking, insurance, telecommunications and business-to-business companies, but its implementation can be also extended to other types of businesses. For instance, if you’re targeting high-net worth customers that would by more expensive items, then you should choose the short-term CLV calculation model; on the other hand, if you’re targeting customers that prefer purchasing lower-cost items, but repeatedly over a long period, then you might use a long-term CLV calculation model.

Calculation of customer lifetime value

The difficult thing about CLV is that it deals with predicting future business activities, which makes it rather tough in terms of calculation. It also involves rather difficult mathematical and statistical representations, which makes it inconceivable for an average merchandiser. However, there are various models that can be implemented depending on the type and size of your enterprise and the input data you possess at the moment. They range from specifically difficult to the easiest in terms of usability, so you can choose exactly the type that will make your time, money or both saved.

Generally, for determining the input data for CLV calculation the following steps must be taken:

  1. Prediction of remaining customer lifetime (usually expressed by years)
  2. Prediction of future revenues (taken yearly), based on estimated amount of goods purchased and price paid for them
  3. Estimated delivery costs
  4. Calculation of the net present value of the three previous amounts

The next step is to choose the most appropriate CLV calculation model. You must know that there are three main characteristics of each model: accuracy, simplicity, and cost. When deciding on the best model, you will unfortunately have to choose two out of three of these characteristics. Thus, the simplest model will be cheap, but likely inaccurate; the most accurate model will be cheap, but really complicated; and the inexpensive model will be accurate, but not simple.

1.1. Let’s first take a look at simple and inexpensive CLV:

CLV = AOV × APY × Profit Margin, where

AOV is average order value (total revenue ÷ number of orders),

APY is average purchases (per year). The formula for calculating APY is the following:

APY = Total number of purchases ÷ Total number of customers

This model seems to be really simple by the method of its calculation, but in result you will get just an approximate CLV amount per given period, so you must act carefully when deciding upon the following marketing scheme. This model is good in that it can be adjusted for any period, but the longer period you suggest for analyzing, the more inaccurate the results will be.

1.2. There is also an alternative basic CLV model which is nicely applicable to small businesses with constant margins and retention rates. This model assumes that in case when the customer is not retained (retention equals 0), he’s never going to interact with the company again. On the contrary, if retention equals 1, the customer is retained and accounts for the company’s future margin for the unlimited period. The margin value in this model is supposed to be obtained at the end of the first period being analyzed. The final CLV calculation formula will look as follows:

CLV ($) = Margin ($) * (Retention Rate (%) ÷ [1 + Discount Rate (%) – Retention Rate (%)])

2.1  Accurate and Inexpensive CLV is the one that requires special technical abilities from the merchants having decided upon their business improvement.  But this might be really useful for those having unique business model. This model includes additional important data such as discount rate, time value of money, and average customer lifetime, which is expressed by years and tells us how long a customer keeps on dealing with your company until he leaves you for good.

For calculating accurate and inexpensive CLV you can use a range of online resources that use their own adapted formulae giving the most exemplary results.

Calculating CLV with Google Analytics

Before actually getting to Google Analytics you will have to prepare a separate CSV file where you include your input data. Then you will have to import this file to Universal Analytics which is a special service devoted to analyzing and monitoring data captured from your e-commerce website. There you have two ways of determining CLV: through Measurement Protocol or Dimension Widening.

  • With the help of Measurement Protocol you can send hits to Google Analytics server, which looks like sending a request to a specific URL with all the input information contained. This procedure is run on scripts, so you don’t even have to use JavaScript tags.
  • Dimension Widening allows you to upload a CSV file containing a primary dimension key and all the additional information you want to store in other dimensions.

Dimension Widening is considered to be the easiest in terms of CLV determining, so you can use this manual to calculate your individual CLV.

Calculating CLV with Kiss Metrics by the example of Starbucks

The company utilizes several formulae for determining their CLV which include a number of constant rates:

t – average customer lifetime

r – customer retention rate

i – discount rate

p – average gross margin per customer lifetime.

The simple CLV equation will look as follows: 52(a) × t

The custom CLV equation will look as follows: t(52 × s × с × p)

The traditional CLV equation will look as follows: m(r/(1+i-r))

However, these equations will only give you the average CLV rate of all your customers. If you intend to determine the high-value customers and distinguish them from unprofitable customers, you should evaluate the amount of money each customer spends on your items during a long period. Then you can use one of the given equations again to see which of the customers if profitable and which is not. Usually customers with lower CLV are less profitable than those with higher CLV.

You can see the detailed Starbucks CLV infographics here.

Helpful CLV calculation table from WindsorCircle

Ecommerce CVL: Magento Customer Lifetime Value.

WindsorCircle website offers their own custom CLV table which you can download as a separate file and adjust it according to your personal data. All the calculation formulae were already included in the table, so you should only type the inputs in appropriate columns.

2.2. More difficult CLV models usually require having initial technical background, and they also include more inputs that must be previously calculated. Thus, you’re going to deal with:

  • Churn rate, which is the amount of customers (in percent) that are likely to reject the company’s services at a particular moment in the future.
  • Retention rate (which is also used in the previous model) is basically one minus churn rate. Any CLV model can only include either churn rate or retention rate; if there is one churn rate in the model, it means that its value is constant throughout the given period of company-customer relationship.
  • Discount rate – the fees that merchants have to pay for accepting payments from their customers.
  • Contribution margin is the selling price per unit minus the variable cost per unit.
  • Retention cost – the amount of money a company has to spend to retain a customer.
  • Period (or horizon) – the period which is subject to analysis. The most common period in CLV calculation is a year; however, it’s reasonable not to exceed the period of 7 years because it may affect the accuracy of subsequent results.

3. Simple and accurate CLV requires considerable investments to get CLV rates. Usually it’s done by using exclusive calculators and apps. Among those companies offering their services are Vantage Analytics, RJ metrics, Kiss metrics, and Custora. There you can make regular calculations of CLV to estimate the changes in the current marketing scheme you’re following and get some useful advices as for customer retention and profit gaining.

If you don’t have enough time to spend on such tiresome calculations, you can always use the simplified calculator provided specifically for e-commerce merchants by the service

What to do next

After you get the average CLV, you will have to segment your customers to find the most valuable ones in terms of long-standing relationship. There are two main types of customer segmentation:

  • According to the source of acquisition (social media, organic search, banner ads, etc.)
  • According to demographics (age, sex, nationality, etc.)

Thus, if you find out that the greater CLV belongs to those users that came to you from social media sources, your future marketing scheme must be directed to social media as well. As for the demographic segmentation of customers, you can determine which country’s users are more profitable or whether it is men or women that are likely to spend years with your company.

Advantages of customer lifetime value

Although being rather complex by its implementation, customer lifetime value has many advantages as for the long-standing planning of your e-commerce project development. With such data in mind you can prepare yourself for the most appropriate marketing scenario with the minimum of expenses. Thus, the advantages of CLV are obvious:

  • It gives you the ability to manage your long-term relationship with a customer.
  • It defines the most appropriate amount of investments that can be used for marketing and sales boosting.
  • You can predict the consequences that the value of your customers will have in result of implementation of the given management strategies and marketing investments.
  • It allows you to generate even more sophisticated advertising strategy.
  • Promotes the merchants’ shift from wasting money on “cheap” and temporary customers in favour of those who are likely to become your long-term clients.
  • Helps to wisely distribute the company’s resources to achieve the best return from the customers.
  • Is very handy in determining the most appealing category of users among your audience.
  • Is a good way to measure the overall loyalty of a customer, and loyalty means a lot, because it costs less to retain and deal with existing customers rather than to constantly look for new ones without even knowing whom you’re looking for. Thus, the probability of selling to an existing customer equals 60-70 percent, while the probability of selling to a new customer is reduced to only 5-20 percent.

The common mistakes of CLV application

Because CLV helps to determine quite a wide range of data, its versatility is often exaggerated by the merchants. You should be very attentive when quantifying your company’s CLV in order to prevent unpleasant miscalculations and, accordingly, losses in future revenues. So the common mistakes are:

  1. Identification of unprofitable customers. Merchants tend to think that unprofitable customers are those that would never make a purchase in your store and so must be ignored. However, they are actually capable of bringing little revenues, and there are individual ways and models to calculate their specific advantage.
  2. Misconception of such terms as revenue and net profit. It’s wrong to assume that revenue equals actual profit you get from the customers. Accordingly, net profit is the finite money you get after paying back the fees for revenue.
  3. Relying on intuition. Underestimation of CLV in favour of approximate predictions on the basis of specific demographics analysis of a customer group can cause serious inaccuracies in getting profits from certain audiences of your e-commerce website.

But perhaps there is sense in combining various methods.

It was always assumed, though, that the main way of attracting the high value customers is to organize an effective marketing scheme. According to this scheme, it was always possible to convert low value customers into profitable ones just by making right investments in the right time. And this is obviously true. Moreover, it’s widely admitted that CLV models are based on inaccurate calculations, and they don’t consider low profit customers at all. Nevertheless, the most reasonable in this case is the strategy that would take into account data from CLV calculations and implement this data for planning the most effective marketing campaign for your business.

How to increase your customer lifetime value

Ecommerce CVL: Magento Customer Lifetime Value.

The main thing to manage if you want to improve your CLV is to provide your customers with the instant support and attention so that they could feel they’re important and valuable to you.

  1. Provide in-time consulting, discount informing and general customer education through e-mail.
  2. Consider that each customer of yours is a potential customer with high CLV, so don’t give up on those customers that for some reason don’t purchase from your store – they simply may not have money yet to do it.
  3. Remember about customer loyalty which includes constant interaction with each of your customers. Implementation of the individual approach and sharing their values are the key principles of sustaining this loyalty.
  4. Recalculate your CLV at least once in a month and record all the data so that you could estimate the effectiveness of the strategy you’re using through time.
  5. Because CLV highly depends on such factors as average order value, purchase frequency, and customer lifetime, you must keep in mind the idea that if one of the three factors is on the low level, it means that all the efforts must be made to improve its rates; otherwise, the general CLV rate will be negatively affected.
  6. Find the sources of the most valuable customer acquisition.
  7. Use demographic analysis to specify the segmentation of your customers.
  8. Encourage your customers to purchase multiple products. For instance, if you deal with clothes, you can offer your clients different colors or sizes of the same item so that they could purchase it not only for themselves, but for their friends and family as well. The main thing is to make the first time purchase item the most general and popular among the most of your clients.
  9. Provide a live chat on your website to prevent potential check-out failures and negative experience of your customers. Although the process of check-out is considered to be well-known and easy to manage, there are a lot of cases when users become confused with the website design and interface and can easily make mistakes during the shopping cart manipulations. Having been failed once, they would hardly come back to your store again. That’s why you should be available for offering help and support before the purchase has been made.

10. Provide as many payment method options as you can.

11. If your current revenues are better than you even planned, you could try to be more generous and cancel any fees for the items return. Your customers would really appreciate that.

CLV calculation in Magento

Ecommerce CVL: Magento Customer Lifetime Value.

Unlike any other CLV calculation methods described above, dealing with Magento requires application of slightly different approaches. The first option is requesting for data. Although Magento provides a great deal of built-in reports, it doesn’t include CLV reports, which means that you will have to create it yourself.

1.1. If you decided to deal with MYSQL reports, you will first have to install Clean_SqlReports module and log into your Magento admin panel. The next thing to manage is to prevent other users from entering and editing your code. To do this, go to “System>Permissions>Roles”; then attach at least one role to users you don’t want to have access to your reports and uncheck the option “Add/Edit Reports (DANGEROUS)”.

The module has two types of implementation: plain table and Google Charts API. In terms of CLV calculation, plain table report will be used. The report suggests making a list of top 500 customers and displaying their lifetime order value, general number of orders and the last date the made a purchase. To edit the report, go to “Reports > Special Reports”, then choose “Add report” and give it the name. Then put in the following SQL query code:

Finally, save the report and run it.

1.2. Here we’re going to run a simple MYSQL query that can provide you with the most important information about your customers including their e-mail addresses, names, and total amount of purchases made since they first entered your website.

The query is the following:

2. Another option is the use of Magento extensions. One of them is developed by Licentia and the other one – by Magebird developers.

Ecommerce CVL: Magento Customer Lifetime Value.

3. Even the more progressive tool for integrating CLV calculator with your Magento is Retention Hero tool. It’s a very profound addon that can handle all the CLV calculation routine, while you get the most accurate results for determining the best marketing strategy for your e-commerce website.

Ecommerce CVL: Magento Customer Lifetime Value.

  • Retention Hero constantly analyzes the history of your orders to find the most profitable behavior patterns. Thus you’re going to target the high-value customers and retain them in the most effective way.
  • Moreover, the tool is capable of analyzing the lifecycle of your customers by dividing them into corresponding groups: new customers, one-time ones, active, at risk, and lost ones.
  • Retention Hero performs the most accurate CLV calculation and effectively predicts which customers are likely to keep a long-standing relationship with your company. You can find Retention Hero tool on its official website here.