Businesses looking to find their footing are often obsessed with metrics. However, not all metrics are created equal for those hoping to survive over the long haul.
The difference between businesses that fail and those that scale? Understanding what their customers are worth by the numbers. It doesn’t matter what kind of business you want to start. From the world of e-commerce to brick-and-mortar stores, scaling is near-impossible until you determine your customer lifetime value.
Breaking down your CLV
Customer lifetime value (CLV) represents a relatively simple concept that can make or break a budding business. In short, your CLV is the total dollars that a customer will spend with your company over the course of their lifetime.
There are numerous ways to calculate your CLV, but this straightforward formula perhaps illustrates it best:
(Average Value of Sale) X (Number of Repeat Transactions Per Year) X (Average Retention Time) = CLV
Don’t let the math freak you out. Again, the concept is simple.
Let’s say you run an e-commerce store that sells seasonal clothing. The average value of any given sale at your shop is $30, your customers on average purchase from you twice a year, and they typically stick around for two years. In this scenario, your CLV would be $180 (30 x 2 x 3).
But why does this number matter so much?
Why you need to know your CLV
The key benefits of understanding your CLV are threefold:
- Knowing how much your customers are worth shows you what you need to bring new people into your funnel, especially since acquiring new customers costs more than retaining them.
- Your CLV directly influences your marketing strategy. From purchasing media and hiring sales personnel to looking for affiliates and beyond, knowing what your customers are worth will ultimately determine your marketing budget.
- You will avoid scaling too quickly and have a better understanding of what your business requires to break even.
The takeaway here is that having your CLV handy means that your business’s budget and earning potential are rooted in numbers rather than a guessing game. Yet despite there being a need to understand your CLV, many new businesses struggle with the concept.
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Setting up a system that predicts your customers’ value
The problem for a budding businesses and its CLV is perhaps obvious. That is, determining how much your customers are worth is easier said than done if you don’t have a particularly large sample of customers or haven’t been around long enough to have numbers to crunch. Similarly, you may have no indication of churn rate or what your business’s cash flow looks like for the long term.
Does that mean that new businesses are expected to fly blindly? Of course not. The solution is to create a system that essentially predicts your CLV.
Perhaps one of the best illustrations of such a system comes from the world of app developers, a high ad-spend vertical with fierce competition. Developers essentially set up a series of actions for users to take within a certain time frame to estimate how much those users will be worth in the long run. Those actions might include:
- Completing a tutorial
- Making a purchase with their app
- Leaving a rating on the app in the App or Play Store
Each of these actions serves as a sort of indicator as to how engaged their audience is. The more engaged they are, the higher their potential CLV.