CALCULATING

CUSTOMER
LIFETIME VALUE

HOW-TO GUIDE
 Calculating Customer Lifetime Value
HOW-TO GUIDE

Is your organization pouring out a large budget for sales & marketing activities and not seeing
the returns? Is your organization focused solely on short term cash flows rather than long term
profits? Is your organization unaware of how to calculate the potential profit of each client you
bring in the door? If you answered yes to any of these questions, learning what customer lifetime
value (CLV) is and how to calculate it may benefit your organization.

Download Demand Metric's Customer Lifetime Value Calculator (CLV).

Common sense tells us that the longer a customer is in relationship with a company, the more prof-
itable that customer relationship is. However, many companies put the emphasis on new customer
acquisition and not enough effort is made to retain existing customers. This is a mistake, because the
financial impact of retaining customers is substantial: companies can increase profits by as much as
100% by retaining just 5% more of their customers. For these reasons¹, CLV is a crucial metric that most
organizations overlook mainly because its definition and purpose are not entirely known.

Understanding the monetary value each customer represents to your organization can help you
budget correctly for your business needs, strategically plan your marketing initiatives and improve
long-term relationships with your customer base.

This How-To Guide details the definition of CLV, the advantages of calculating CLV and the stan-
dard formula for calculating CLV.

What Is Customer Lifetime Value?

Customer lifetime value goes by many names and abbreviations including CLV, lifetime value,
user lifetime value, LTV and CLTV. Although its designations are far-reaching, they all share one
general definition:

“The net present value of the cash flow

relationship with a customer.”
www.zurb.com

2 CALCULATING CUSTOMER LIFETIME VALUE HOW-TO GUIDE

More specifically,

“Customer lifetime value (CLV) […] is a prediction of the net

profit […] attributed to the entire future relationship with a
customer. The prediction model can have varying levels of
sophistication and accuracy, ranging from a crude heuristic to
the use of complex predictive analytics techniques. Customer
lifetime value (CLV) can also be defined as the dollar value
of a customer relationship, based on the present value of the
projected future cash flows from the customer relationship.”
www.wikipedia.com

Customer lifetime value (or CLV as we will refer to it for the remainder of this guide) attempts to
assess the true, long-term value and/or profitability of each client/customer. The purpose of this
metric is to help businesses identify how much to invest in the development of each account.

Advantages Of Measuring CLV

Calculating CLV provides a multitude of benefits. In our opinion, the most important advantages
of identifying CLV are:

Valuation of a Customer Relationship – Knowing the dollar value of customers over the duration of
the relationship allows you to better assess current and future profitability. The insights gained from
this valuation enable more effective investment decisions about customer acquisition costs.

Evaluates Proper Investment for Each Customer – Measuring CLV allows you to develop a more
accurate sales & marketing budget. When you know the CLV, it makes it easier to justify more expen-
sive account development activities early in the relationship with the customer.

Forecasts Potential Future Value of Customer Relationships – The CLV formula not only esti-
mates current value of a client, but also takes into account the potential value of a client. With a
numeric value for potential revenues, your organization can more accurately forecast potential
total cash flow for future months and/or years.

Emphasizes the Importance of Cultivating Long-Term Relationships – an understanding of CLV

helps put the focus on client retention within your organization. Inherently, CLV encourages busi-
nesses to move past the short-term expense and instead view customer relationships through
the lens of long-term profitability. Thus, nurturing customer relationships to eventually obtain
these potential profits becomes an integral theme in client retention long-term.

3 CALCULATING CUSTOMER LIFETIME VALUE HOW-TO GUIDE

Standard Formula For Calculating CLV
Although organizations tend to differ in the way they calculate CLV, many of them use a variation
of the formula below:

CLV = M X ( RR
1 + DR - RR )
M = gross profit margin per customer lifespan ($)

RR = the percentage of customers that repurchase/renew for your product/service over a certain
period of time (%)

DR = the interest rate used to calculate the current value of future cash flows (%)

This is the traditional model used to calculate CLV. As mentioned above, most organizations
customize this model to suit their needs and some organizations use more advanced models that
require in-depth calculations and the assistance of a specified tool.

Bottom Line
Customer lifetime value is an indispensable metric that can serve the long term monetary
and strategic goals of your company.

Since many organizations are unaware of the importance of this metric, understanding the
purpose and advantages to CLV will put your company ahead of the curve when it comes to
retaining and nurturing your customer relationships for the benefit of your bottom line.

4 CALCULATING CUSTOMER LIFETIME VALUE HOW-TO GUIDE

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