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Sensible marketing budgeting using the Customer Lifetime Value (CLV)

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To the German article

What share of your marketing expenses do you want to allocate to which customers? Our partner uptain answers this question using the Customer Lifetime Value (CLV). You can find out more below.

Marketing activities can get very expensive. To increase the efficiency and benefit of your marketing, your decisions should be based on a solid foundation. That’s why you need a key figure that not only takes your short-term revenue into account but also your customers (business relationship) as a whole. This way, investments that only become profitable after a certain period of time receive the attention they deserve.

Take, for example, customer retention which leads to more repeat customers and makes up the majority of revenue in many companies. Although at 92%, first-time buyers make up by far the bulk of an online shop’s traffic, the 8% repeat and regular buyers provide 41% of the revenue. In turn, these figures should mean that a proportional share of marketing investments go to customer retention. To the contrary: 78% of marketing expenses are used to acquire new customers.

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An important key figure: the Customer Lifetime Value (CLV)

But what share of your marketing expenses do you want to allocate to which customers? There is no key figure that can answer this question more satisfactorily than the Customer Lifetime Value (CLV). The CLV indicates the customer value over the entire span of the business relationship by incorporating both past and future revenue and expenditure. 

The advantage: The CLV permits practical operational decisions and is extremely workable as a result. If a customer’s value is high, then higher investments in customer care will pay off accordingly. However, if it’s low, then the money can be saved and be invested more cost-effectively elsewhere.

Calculating the CLV step by step

To begin with: There are several formulas that all indicate the CLV. Depending on how you prioritise, you will get different values. It’s especially important that the same formula is applied, as only then can a comparison be drawn between individual customers. We recommend the following approach:

1. Segment your customers

In order to determine which customers require how many resources, start out by segmenting your customers. Choose your segmentation criteria sensibly. For instance, would you like to segment your customers by demographic characteristics? The following steps must be taken separately for each segment. 

2. Determine the average initial investment

This includes your marketing measures, starting with SEO, all the way through to social media activities. Calculate the initial investment by dividing the investments into acquiring new customers over a specific time span by the number of acquired customers over the same time span.

3. Identify ongoing customer care expenses

There are not only expenses for acquiring new customers but also for customer support and other customer retention care. It’s best if you identify the expected investment per customer for one year.

4. Calculate the expected annual turnover of the business relationship

Then, calculate the expected annual turnover of the business relationship. For this calculation, you will need the average purchase frequency (e.g. per year) and the average order value. When you multiply these two values, you will get the expected annual turnover of the business relationship.

5. Determine the average duration of the business relationship

Ideally, you will draw on your experience for this purpose. Due to missing empirical data, more recent online shops have difficulties identifying the average duration of the business relationship. In this case, it’s best to fall back on estimates or values taken from comparable online shops.

6. Identify the discount rate

The discount rate is crucial in order to calculate the present value of future revenue. As that is exactly what we want to do with the CLV, it is absolutely essential. For the majority of sectors, a discount rate of 10% makes the most sense.

7. Calculate the CLV

You can calculate the CLV using the values you have now collected. To do so, you will need the following formula:

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Example: Online electronics shop

An electronics online shop wants to budget its marketing investments more efficiently and is therefore calculating the CLV of its customers.

1. Segmenting customers

The shop decides to segment by acquisition channels to calculate which channel acquired the most valuable customers. In the following section, we will calculate the CLV for the customer segment “social media”.

2. Identifying initial investment

For the customers in the “social media” segment, the initial investment is $60 on average.

3. Identifying expected (annual) investments

Customer support for one customer costs the online shop $20 per year.

4. Calculating the expected turnover of the business relationship

As every customer from the segment orders on average three times per year, and the order value is on average $100, the expected turnover of a business relationship equals $300 per year. 

5. Determining the duration of the business relationship

The customers acquired through social media activities remain as customers for three years on average.

6. Identifying the discount rate

The discount rate is 10%.

7. Calculating the CLV

The online electronics shop now adds the values to the formula and gets the CLV for the customer segment “social media”. If it then calculates the CLV of the customer segment “organic search” and that value ends up being higher, then it’s worth investing more into search engine optimisation.

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Increasing the Customer Lifetime Value

The CLV does not only work for efficient marketing budgeting but also for measuring customer retention and customer satisfaction. Thanks to different measures, online retailers are able to use uptain to measurably increase customer value:

On-site conversion optimisation

The higher the acquisition costs are for a customer, the lower the CLV will be. Converting the existing traffic means distributing the investments in customer acquisition across more customers. One way of doing so is with the recovery of shopping cart abandoners by using activation popups. Traffic that was driven to the online shop in a costly manner is more efficiently used with every recovery, which leads to the investments being distributed between more acquisitions. This way, the acquisition costs for a customer are considerably reduced.

Increase purchase frequency

Because the purchase frequency has an enormous influence on the CLV, you automatically increase the customer value when you increase the purchase frequency. If a customer buys from your shop three times rather than twice per year, the CLV increases by a third on average. Abandoner emails remind repeat customers of their shopping cart when they have abandoned it so that a transaction becomes more likely, which then increases the purchase frequency.

Prolonging customer lifetime

The customer lifetime, i.e. the duration of a business relationship, also impacts the CLV significantly. If the customer lifetime is prolonged through suitable measures, even by “only” one year, this change will improve the CLV noticeably. Our newsletter opt-ins turn unknown visitors into known customers in order to maintain the relationship going forward and successfully prolong customer retention.

The CLV’s various applications make it an attractive option, especially for online shops. Calculating and utilising it not only enables sensible marketing budgeting, but also makes it possible to measure and increase the actual customer value.