In what way do you measure the success of your e-commerce store at this time? Are you like many who focus on aspects like revenue and sales?
There’s no doubt that these two metrics are important in monitoring content and campaign performance for the short term, but they really don’t give you a bigger picture of what’s to come. Knowing what your current sales numbers are will only leave you with just a small glimpse of your real financial status.
On the other hand, your Customer Lifetime Value or CLV is one of the most crucial factors that determine the present status of your business as well as its success in the future. This metric is capable of predicting just how much your customers are truly worthy even though it is often overlooked. When you can measure the net profit you will get over the course of your customer-business relationship, you can pinpoint just how valuable they are to your company.
Aside from that, CLV also provides essential insight on the amount of money you need to be spending in getting customers, as it tells you how much value they will bring to your business in the long term. Instead of just focusing on short term aspects that will barely keep you afloat, you will know which customers you need to focus on and why.
The Importance of Customer Lifetime Value
You can think of Customer Lifetime Value as an in-depth look at the advantage in getting and maintaining any customer. This is especially true since not all of them can give you the same value.
Being the owner of a business, you’ll have to spend time getting the right customers – those people who will take your business to the next level.
Although CLV is significantly crucial, it’s normally quite hard to measure. For those of you who have tried calculating CLV in the past, then you know just how complicated the formulas and algorithms can be.
The good news is that there are now much easier ways to calculate CLV, but there’s also a good reason why those formulas are complex in the first place. It is difficult to predict customer behaviours and may appear quite random at a glance which is why CLV is an inherently sophisticated metric to keep an eye on.
Consider this for a second. There may be some customers who choose to make minor purchases each week while others only buy once a year but do it big. And there are all kinds of combinations between these two. So how can you accurately predict how much your next customer is going to contribute to your company?
Even if there are advanced approaches in forecasting CLV, this post will talk about the more straightforward method to get the details you need to improve your customer acquisition right away.
Segmenting Customers Using RFM
Prior to getting into it with Customer Lifetime Value, it’s important to look at the fundamental aspects of analysing it in the first place. These metrics are Recency, Frequency and Monetary Value thus, RFM.
RFM is a way to organise your customers from the least to the most value based on the following factors:
Recency – this refers to the last time a certain customer bought something. Customers that purchase recently would most likely be open to repeating it compared to a customer that hasn’t made a purchase in quite a while.
Frequency – this is the number of times a customer has purchased from your business within a set period of time. Customers who purchase often have the highest probability of coming back than those who rarely do.
Monetary Value – this metric is the amount a customer has already spent in a similar time frame. Customers who spend more will likely return than those who spend less.
Segmenting with the RFM method will allow you to analyse groups separately and know which of your customers provide the highest CLV.
To get started with RFM in organizing your customers, there are three pieces of data you need to look out for. These are the date of their latest transaction, the number of transactions they’ve done in a regular period (within a year is best), as well as the total amount that was spent.
For those with a Shopify store, these statistics can be found under the Reports section of the Admin. When you head that page, you need to click Sales by Customer Name to find the data such as order count and total sales.
How Can I Calculate Customer Lifetime Value?
Once your customers have been segmented with RFM, the next step is to determine each segment’s value to see which of these customers are the most valuable. There are three important pieces of data you need to track down to calculate your Customer Lifetime Value within a set time period. These are: average order value, purchase frequency and customer value.
Average Order Value
This value indicates the average amount of money a customer spends every time they make a purchase. You can get this number by taking the total revenue and then dividing that by the total number of orders you have.
For those with a Shopify store, this information can once again be found in the Reports section of the Admin and then looking at the Sales by Month. You then simply divide this number by your Order Count for the previous year.
This is the average amount of orders that each of your customers places. Utilizing the same time period as that of your Average Order Value calculation, you also need to divide the total number of orders by the total number of unique customers. The result here is your Purchase Frequency.
Shopify merchants may find this data in their Reports section under Sales by Customer.
The Customer Value is the average monetary value a customer brings to your company within a timeframe. To acquire this, you simply have to multiply your Average Order Value by your Purchase Frequency.
Calculating Your Customer Lifetime Value
When you’re done calculating your Customer Value for every segment in your customer base, you need to evaluate your CLV next. This can be done by multiplying your Customer Value against the average customer lifespan. The latter is the length of time that a relationship with your customer normally lasts before they begin to become inactive and stop purchases permanently. With regards to customer lifespan, you need to understand the difference between non-contractual and contractual business.
The majority of online shops are non-contractual, which means that after a purchase has been made, the transaction is technically over. The thing that makes these types of business difficult is with regards to identifying when an active customer becomes inactive.
However, there are a few online stores, such as subscription businesses that can be classified as contractual. In a contractual scenario, the owner is aware when a customer becomes inactive as they will announce this by the end of their subscription or contract. This kind of business makes it easier to identify the average customer lifespan compared to the non-contractual approach.
Here’s How You Can Increase Customer Lifetime Value
Although the results you have acquired from your calculations may seem exciting, you shouldn’t slow down yet. There is always room to improve. Here are a few more tips to let you get the most out of your customer relationships by developing new opportunities that enhance their value:
Encourage Them to Spend More
An essential part of increasing the lifetime value of your customers is to encourage them to spend more whenever they make an order. Doing so lets you boost your overall average order value as well.
The pricing you have plays a crucial psychological role in how much a buyer spends and what customers decide to purchase. Some ideas that may improve your pricing model are:
Making the left digit as low as possible – when you sell costly items, try to make the left digit stand out to your customers’ eyes by making it as low as you can. This tricks the mind into thinking that the price is actually smaller. For example $99 seems a lot cheaper than $100.
Do comparison pricing – are you offering several models of the same item? Have them lined up and compare the advantages of each model to justify its pricing and help your customers decide.
Social proof can be powerful – incorporate Instagram feed into the pages of your products using apps like Shoppable Instagram to let your customers know who is using your items. This allows you to inspire your people to go and buy your product.
Free shipping deals are great – when you offer free shipping, think about setting the threshold of your discounts higher. This could mean $50, $100 or even more depending on your company. When your customers are close to reaching the threshold, they can easily justify adding a few more items to avail of the free shipping.
Convince Your Customers to Visit Often
You can improve your CLV a lot better by not simply encouraging them to keep coming back, but also to do so more frequently. Below are some tips to enhance your customer frequency and lifespan by giving them more incentive to visit often.
Make getting a package memorable – your customers love being delighted and surprised every time they unbox an item they bought from you. That is why you need to add some extra love and care by giving free gifts, customised notes and more when sending a package.
Newsletters are effective – any business can benefit when they put their heads on email marketing. Try to keep your customers updated with upcoming sales, product restocks and unique deals with a well thought out newsletter.
Loyalty programs keep buyers around – you can do a loyalty program to show your beloved customers that you reward them with gifts for making repeat purchases.
Subscriptions may be the way to go – are you selling products that people have to buy often such as with consumables? Maybe you can set up a subscription program to lock them with your company. This makes it easier for both you and your customers in the long run.
Start Leveraging Your Customer Lifetime Value
Now that you have your CLV at the ready, you’re now prepared to develop a more efficient and smarter campaign by optimising your spending and targeting.
One of the main functions of CLV is to let you keep your Cost per Acquisition as minimal as possible. If you aren’t aware how much you spend in getting new customers, you simply have to divide your total marketing or sales budget on a certain time period by the number of new customers you have gained in that same time. This is how you get the average spending you do when getting a new customer.
Your Return on Investment or ROI is the difference between your Customer Lifetime Value and Cost per Acquisition. This is the total money you get from a customer relationship once you’ve deducted the money you spend to jumpstart the relationship initially. To stay afloat, you have to maximise your ROI.
When you know your CLV, you also get to know how much you are able to afford when spending for paid ad campaigns on Facebook and Google. You can determine how much you should put into your campaigns by knowing your conversion rate first.
For example, if you have a CLV of $100 and your marketing campaigns are converting at 10%, then the maximum you should bid needs to be 10% of your $100. In this scenario, you can spend $10 for each click without overspending.
Success as an online business isn’t about bringing in customers, it’s about driving in the right customers to your brand. Now that you know how to calculate the lifetime value of your customer base, you can start creating more effective and efficient campaigns moving forward.
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