How much can you afford to spend to acquire a new customer? It’s a big question, and one I see people getting wrong every day. The reason? They have no idea what their Customer Lifetime Value (CLV) is.

CLV is the single most important marketing metric. Period. It can tell you if your difficult ad campaigns should continue, how big a proportion of your revenues to allocate to marketing and even how much you can sell your company for.

If you don’t understand why you need to be tracking CLV, read on.

Let’s start with what CLV actually is. There are a number of different ways to calculate it but in essence the idea is to capture just how much profit you will make from an individual customer over their entire lifetime, i.e. from when you acquire them through to when they finally stop buying your products. In simple terms it represents:

(Ave. transaction value) x (profit margin) x (Ave. transactions/customer)

This can be refined by limiting the number of years or months considered, or by discounting future cash flows, and especially by segmenting your customer base and using CLV to identify the most valuable segments.

Until you know your lifetime customer value, you do not know how much profit a customer brings in. As a result you cannot know how much to spend on acquiring that customer if you want to be profitable. You have no idea if your marketing is sustainable. The end-result is often that companies end up being stuck with only doing free advertising because they do not know how much they can spend on advertising.

CLV can provide an exact valuation for a company’s most important asset, its customer relationships. CLV is rarely mentioned in an e-commerce company’s Annual Report yet it predicts the net profit resulting from the entire set of future relationship with customers. CLV also empowers online retailers to build business strategy and allocate marketing resources to focus on the most valuable customers – those that buy more; purchase more often and tend to be loyal to the brand.

Knowing your CLV for e-commerce can help you to:

  • Segment your customer basis more accurately and profitably;
  • Define your objectives – growth, turnover, future sales, net profit – with an understanding of what is needed in order to achieve them;
  • Balance other KPIs such acquisition cost, repeat purchase rate, growth in average shopping basket value, churn rate and more;
  • Establish solid metrics for customer satisfaction;
  • Evaluate and optimize your marketing tools, tactics and channels;
  • Target your loyalty, retention and reactivation programs towards the right customers;
  • Cross-sell and up-sell based on individual patterns of buying.

Once you calculate CLV for all your various customer groups (potential customers, existing customers and defected customers, for example) – or current customers as a minimum – you will have an exact picture of your most valuable assets: market position and the strength of your customer relationships. These figures can not only help you to optimize your marketing every day, but can also be used as part of a valuation for corporate mergers and acquisitions.

If you aren’t using CLV already to guide your marketing efforts, now is the time to start. I’ll write more about CLV in the coming weeks with tips on how to calculate it and the impact of including different variables and the insights they provide.

Chris Trayhorn

In addition to running and the Blue Book, Chris is also the CEO of mThinkDigital, a San Francisco-based digital marketing agency focused on e-commerce and customer acquisition.