Chetna

Customer Lifetime Value (CLV) is a metric that shows the total revenue any business can expect from a single customer account throughout their business relationship. This metric considers a customer’s revenue value and compares it to the company’s predicted customer lifespan.
This is a prediction model which have varying levels of complexity and accuracy, from experimental to the use of complex predictive analytical techniques.
Below is one of a simpler example to understand the CLV formula
Assumptions:
·       Profits generated by Customer A each year = $1000
·       Number of years since they are customer of the brand = 5 years
·       Cost to acquire the customer = $2000
The CLV of this customer would be:
Annual profit x # of years they are customer – acquisition cost
$1000 x 5 - $2000 = $3000
 
Another detailed example of CLV formula with more complexity by changing the initial assumptions:
 
·       Annual revenue per average customer = $2000 per annum
·       Product costs associated with Avg customer’s purchases = $500 per year
·       Firm spends additional $100 an year per customer for Customer Services
·       Annual retention rate or loyalty rate = 80%
·       Average costs to acquire new customer = $1000
 
In such a case, we have similar challenge to the previous example but the information needs to be modified from above data to feed into the CLV formula.
As a first step, we will calculate the averahe annual profit per customer by deducting the two sets of costs i.e. product & service costs from the annual revenue.
$2000 - $500 - $100 = $1400
The acquisition costs here are $1000 but we don’t have the average lifetime of the customer in years. We have the Annual retention rate. This is a common situation in workplace as it is relatively easy from customer databases to calculate the retention rate. So we will now convert a retention rate to the avg number of years that the customer will deal with firm.
100% divided by (100% minus the annual retention rate) or (1/1-annual retention rate)
So for 80% loyalty rate, the average customer lifetime will be:
100% / (100% - 80%) = 100% / 20% = 5 years avg customer lifetime period
Now we have all inputs for simple customer lifetime value formula, we can calculate CLV as:
 
$1400 (profit) X 5(years) = $1000 (acquisition) = $6000