Customer Lifetime Value: Why Your Product Needs It

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Last updated on
October 4, 2023

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Customer Lifetime Value: Why Your Product Needs It

Introduction

Did you know that over 80% of companies are making critical business decisions without understanding the true value of their customers? 

If you're one of them, you could be losing customers to competitors who are making data-based decisions based on CLV and other product metrics

In this article, we'll focus on the bright side of measuring CLV, along with the benefits it brings, as well as on the challenges and limitations of this metric.

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What is Customer Lifetime Value in the context of product development?

Customer Lifetime Value (CLV) is a metric that calculates the total value a customer will contribute to your business during their lifetime.

It enables product development teams to gauge the enduring impact of their actions on customer satisfaction, loyalty, and revenue.

By using CLV to guide their decisions, product development teams can prioritize initiatives that will have a long-term positive effect on customer loyalty and revenue.

Ultimately, the aim is to maximize CLV by creating products that deliver ongoing value to customers, resulting in repeat purchases, increased retention rates, and higher revenue for your business.

By focusing of CLV you can:

  • Predict future revenue: CLV helps you estimate how much revenue a customer will generate for the company in the future.
  • Prioritize customer satisfaction: By focusing on initiatives that improve CLV, you improve customer satisfaction and loyalty, which can lead to increased revenue and profitability.
  • Improve product development: Analyzing CLV data can provide valuable insights into customer behavior and preferences, informing product development initiatives and resulting in products that better meet the needs of customers.
  • Reduce customer churn: Customers with high CLV are more likely to remain loyal and continue doing business with your company, reducing customer churn and increasing revenue stability.

Benefits keeping CLV at a high level

Keeping your Customer Lifetime Value (CLV) high can have numerous benefits for your business, including:

Improved profitability

Improving Customer Lifetime Value (CLV) can help increase profitability by reducing customer acquisition costs and increasing customer lifetime revenue. Since it is cheaper to retain existing customers than to acquire new ones, focusing on CLV can be a cost-effective strategy.

Competitive advantage

To set your company apart from competitors who prioritize short-term gains, maintaining high Customer Lifetime Value is key. This strategy can distinguish your business in a crowded market and gradually increase your customer base.

Better customer insights

To gain insights that can help with product development, marketing, and customer experience initiatives, it's important to understand the factors that contribute to CLV, such as customer behavior and preferences.

Improved forecasting

Forecasting CLV precisely can assist you in preparing for future revenue and making well-informed decisions regarding investment and growth.

Limitations and risks of CLV from the product development point of view

Difficulty in accurately measuring CLV

Calculating Customer Lifetime Value (CLV) can be a complex process that requires accurate data on customer behavior, purchasing patterns, and retention rates. If the data is inaccurate, the calculated CLV will also be inaccurate, which can impact decision-making.

Focus on past behavior

CLV is calculated based on the past behavior of customers and may not necessarily predict future behavior or changes in the market.

Limited scope

The Customer Lifetime Value metric may not fully represent the value of a customer, especially if they bring in new customers or help spread brand awareness through social media or other channels.

Limited insight into product preferences

Although CLV can help you understand the total value of a customer, it may not tell you exactly what products or features the customer prefers.

Not suitable for all businesses

CLV may not work for all businesses, especially those that have many low-value transactions or those in unpredictable industries.

Possibility of ignoring customer satisfaction 

CLV is not a foolproof way to gauge customer satisfaction or loyalty. If you only concentrate on CLV, you might miss crucial aspects that impact customer satisfaction, such as product quality, customer service, or brand reputation.

Risk of underestimating competition

Having a high customer lifetime value (CLV) can sometimes make businesses feel too secure, which can lead them to underestimate their competition or become complacent in their efforts to improve customer satisfaction and loyalty.

How to measure CLV?

Measuring Customer Lifetime Value (CLV) requires several steps:

  1. Specify the time period: Decide the time period you want to measure. For example, you could measure CLV over a customer's first year with the company or over the entire time they are a customer.
  2. Calculate customer revenue: Calculate the total revenue each customer produced during the time period you specified.
  3. Determine customer costs: Find out the expenses related to getting and serving each customer during the time period.
  4. Calculate customer profit: Subtract the customer costs from the customer revenue to calculate the customer profit.
  5. Calculate CLV: Calculate CLV by multiplying the customer profit by the expected time the customer will remain a customer.

For instance, suppose a customer produces $500 in revenue and has $100 in costs in their initial year with the company. It is anticipated that the customer will stay a customer for three years. The CLV for this customer would equal $1,200 (($500 - $100) * 3).

Healthcare web application example

Let's focus on a telemedicine platform that charges patients a monthly subscription fee of $50 to access virtual consultations with healthcare providers. The platform has been in operation for three years, and during that time, the average customer has remained subscribed for 18 months.

To calculate the CLV for this web application, we would use the following formula:

CLV = (Average Revenue per Customer * Average Customer Lifespan) - Customer Acquisition Cost

In this case, the Average Revenue per Customer is $50 per month, and the Average Customer Lifespan is 18 months. This means the Lifetime Revenue per Customer is:

$50 * 18 = $900

To calculate the CLV, we need to subtract the Customer Acquisition Cost. Let's say the Customer Acquisition Cost is $200 per customer. This means the CLV for this web application would be:

CLV = $900 - $200 = $700

So, the CLV for this telemedicine platform is $700. This means that, on average, each customer is worth $700 to the business over the course of their subscription.

CLV alternatives

Customer Acquisition Cost (CAC)

Customer Acquisition Cost (CAC) is the cost of acquiring a new customer. Unlike Customer Lifetime Value (CLV), which focuses on the value a customer brings over their entire relationship with a company, CAC focuses on the upfront cost of acquiring a customer. To calculate CAC, divide the total cost of acquisition by the number of new customers acquired. CAC can be a useful metric for businesses looking to optimize their customer acquisition strategy.

Customer Retention Rate (CRR)

Customer Retention Rate is the percentage of customers who continue to do business with a company over a specific period. Unlike CLV, which focuses on the overall value of a customer, CRR focuses on the proportion of customers who remain loyal to a company. CRR can be a useful metric for businesses looking to improve customer loyalty and reduce customer churn.

Net Promoter Score (NPS) 

Net Promoter Score is a customer satisfaction metric that measures the likelihood of a customer to recommend a company to others. Unlike CLV, which focuses on customer value, NPS focuses on customer satisfaction and loyalty. NPS can be a useful metric for businesses looking to improve customer satisfaction and build a strong brand reputation.

When to choose each option:

  • Choose CAC when your primary focus is on customer acquisition and you want to optimize your customer acquisition strategy.
  • Choose CRR when your primary focus is on customer retention and you want to reduce customer churn and improve customer loyalty.
  • Choose NPS when your primary focus is on customer satisfaction and you want to improve your brand reputation and customer loyalty.

Next steps

By measuring CLV, you can better understand your customers and make informed decisions to increase profitability and customer satisfaction.

However, to truly understand the success of your product development efforts, it's important to track multiple metrics beyond just CLV. By using a combination of metrics and continuously tracking your progress, you can stay on top of product development and set your business up for success. 

Start with exploring other product metrics and compose your ideal set.

Frequently Asked Questions

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Authors

Olga Gierszal
github
Software Engineering Editor

Software development enthusiast with 6 years of professional experience in the tech industry.

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