If you’re running a small business, then you don’t have time (or money) to waste on tactics that aren’t effective.

So how do you make sure that every effort is one that’s worth taking? There’s a lot of trial and error, but there are also certain metrics that can help you determine whether it’s worth putting your precious resources in one direction versus another.

One of the big ones: customer lifetime value (CLV), which allows you to determine the ROI of every customer relationship — and in turn, determine which relationships are most beneficial to building your business and which aren’t.

If you’re new to the idea of CLV, we’re here to help. We’ve put together this quick guide to customer lifetime value, including what it is, why it matters, and how to measure it, plus some quick tips on how to improve it.

What is Customer Lifetime  Value — and Why is it Important?

Customer lifetime value is a metric that businesses use to figure out just how valuable a certain customer is to their company.

Not all customers bring in equal value. Focusing on those who offer the most profitable and sustainable relationships is a great way to ensure that you put your marketing and sales resources where they’ll go the furthest. It also helps your business invest more in customer retention versus customer acquisition — with the former typically being a lot less costly and a lot more lucrative than the latter.

CLV may be the single most important metric for your small business when understanding your customers. It gives you the data you need to answer some BIG questions about marketing, sales, product/services, and how to best serve your customers. For example:

  • Marketing: What’s the most you should spend to acquire a new customer?
  • Sales: Which prospects should I be spending my time with and working to close?
  • Product: How to best align my products/services to match my ideal buyer?
  • Customer Service: How much should I be spending to keep and support a customer?

CLV gives you a picture of how much return business you can expect from a customer, which in turn will help you decide how much you’re willing to spend to acquire new customers for your small business.

How to Measure Customer Lifetime Value

When you’re responsible for a business, you become keenly aware of who your best customers are. That intuitive knowledge is a big part of understanding CLV, but there are also some specific measurements that you can use to hone in on your MVCs (most valuable customers).

Notably, there isn’t one single mathematical equation that will cue you in on a customer’s value. Instead, you need to look at a number of different metrics to calculate your CLV accurately. These include:

  • Annual revenue per customer
  • Average number of years as a customer
  • Average profit margin per customer
  • Customer retention rates
  • Initial cost of customer acquisition (total sales and marketing costs/number of new customers)

All of these metrics give you a different piece of the puzzle that ultimately tells you which customers are bringing in the most value for your business. They also go hand-in-hand with figuring out customer acquisition costs, providing a necessary link between how much it costs you to acquire a new customer and how much value that customer brings you in return.

Let’s walk through an example using some of the metrics above to calculate a CLV: 

Let’s say you own AAA Taxes, and you provide a tax preparation service that charges $500 per customer for your service. It costs you $250 through Google Adwords to acquire a new customer. 

On the surface, it seems like a recipe for disaster. Half of your fee is going to sales and marketing costs. However, once you understand that the average customer stays with you for nine years and delivers a CLV of $4,250, the ROI is undeniable.

  • Revenue from Tax Service Per Customer = $500
  • Average number of years as a customer = 9 Years
  • Initial Cost of Acquisition = $250 per customer

Annual revenue per customer x number of yearscost of customer acquisition = CLV

$500 x 9 – $250 = $4250

Once you determine the CLV, you can better assess how much money to spend to bring in new customers and how much to spend on customer retention. 

There are more in-depth ways to calculate your CLV, such as breaking down your customer acquisition costs in more detail and adding your customer retention rates, but the goal is still the same – to identify customers with high CLV’s so you can acquire more of them, and spot the customers with low CLV’s so you decide whether to focus on improving that segment of customers or eliminating them altogether.

How Can You Use CLV to Determine What Relationships are No Longer Valuable? 

You have about a 60-70% probability of selling to an existing customer versus just a 5-20% probability of selling to a new prospective customer.

Relying on CLV to identify your most worthwhile customers is key to maximizing customer retention potential. On the flip side, identifying which customers are just going to end up costing you more than they’re worth is also just as important. 

CLV is all about efficiency. The more you can center on the customers who are least efficient for reaching your profit goals, the better you can focus on the ones who are. If a customer costs you more in time and money than their overall worth to your business, it’s a sign that you need to shift gears and put your focus somewhere else.

As for ending those unprofitable relationships, it’s a delicate line to walk, but it’s not impossible. If it’s been a longstanding relationship, be open about how you don’t think your solution is the right one for them and make suggestions on alternatives. Make sure to ask for feedback too about what might have gone wrong and where you can do better in the future.

How to Improve Your CLV

To improve your CLV, you need to improve the quality of your customers and customer relationships. Here are some ways to do it.

  • Onboard with purpose. When you bring on a new customer, talk with them about their unique challenges and the value they’re hoping to get out of your product or service, then walk them through the specific features that can help them out the most. Consider sending them a series of onboarding emails to help them learn the ropes and manage expectations. 
  • Stay in touch. Keep connected with your existing customers by checking in on a semi-regular basis and by sending out a consistent stream of content that can help ensure they get maximum value out of their purchase.
  • Prioritize customer service. Be available for your customers when they need you, with an omnichannel strategy that includes not just a phone number and email address but responsive chat and social media. While you’re at it, ensure your customer service staff is highly trained so that when your customers do need help, you’re able to provide it in the most effective way possible.

How to Maximize Your Customer Lifetime Value

Segmentation

Not all customers are equally valuable to your business. For example, B2B may have a different CLV than B2C. Or, maybe a certain lead source, such as Facebook or referrals, are more effective. Use the CLV formula to better understand which customer personas are the most profitable for you.

By identifying which segments or lead sources have a higher CLV, you will be better able to allocate your marketing and sales investment towards acquiring those customers.

Personalization

Customers want to connect with your brand and your business personally. But as time goes on and your business grows it gets harder and harder to engage with all of your customers in an authentic and meaningful way. By leveraging technology like marketing automation, you can better understand your customers’ online behaviors and automatically send the right message to them at the right time – increasing awareness, conversations, and conversions.

Upsell and Cross-Sell

The longer a customer stays with you and the more they spend, the greater the CLV. So if you want to boost the lifetime value for your customers, look for ways to promote new services or products to your existing base of customers. An upsell is when you find a way to increase revenues within the same product or service. An example would be selling a premium tax service as an upgrade for $700 compared to your standard $500 service offering. 

A cross-sell, on the other hand, is when you sell a new product to an existing customer that drives revenue. For example, if you were to sell a financial planning service to every customer that received a tax credit.

Targeting your customers’ unique needs, you can nurture them with content and offers when they are ready to buy, making it easier to drive additional revenue and sales.

The better you are to your customers, the better they’ll be to you. Improve your CLV, and you won’t just have happier customers — you’ll also bring a lot more profit to your business.