Calculating customer value is an important measurement for any business. Understanding your true customer value helps you to make informed decisions on how much you can actually afford to spend on acquiring new customers and, of course, keeping them. And, it might sound obvious, but knowing your customer value in monetary terms helps you to value your customers more when it comes to customer service, giving them a better experience, and thus making customer retention easier, which can only be a good thing.
How do you measure customer value?
Well, it’s not as confusing as you might think. Your calculations don’t need to be precise, just getting a rough idea of your customer value will help you work out your marketing and advertising budget. There are a few different variables you need to consider, so we’re going to talk you through the different stages of calculating customer value.
Calculate your variables
In its most basic form, calculating customer value would look something like this:
Customer Value = Sale Price – Cost of Goods Sold.
This works well if you’re only going to sell one thing once to your customer. But most businesses don’t operate like this, they want repeat custom, so this requires us to also calculate Customer Lifetime Value (CLV). You can calculate customer value over a fixed period of time and calculating customer lifetime value gives you their full value.
So, let’s break this down:
Step 1 – Time period
First, decide upon a fixed time period on which to base your calculations. This could be a week, month, year – the time period is entirely up to you. Just make sure you’re consistent throughout all your calculations.
Step 2 – Average Order Value
Now you’ve decided which time period you’re going to measure, the first calculation you need to make is your Average Order Value (AOV) using the formula below. We’ve picked a time period (28 days) as an example:
Average Order Value (AOV) = Total revenue (over 28 days) ÷ Number of orders (over 28 days)
Let’s say we sold 200 bottles of prosecco over 28 days and we turned over £4,000:
4,000 ÷ 200 = 20
So, our average order value is £20
Step 3 – Purchase Frequency
The next variable to calculate is your purchase frequency (the number of times a customer buys from you in a given period) – be sure to keep your time period the same as the one you used to calculate your AOV:
Purchase Frequency (PF) = Number of orders (over 28 days) ÷ Unique customers (over 28 days)
Let’s say the 200 bottles were bought by 120 different customers, as some customers bought more than one bottle.
200 ÷ 120 = 1.6
So, each customer buys an average of 1.6 bottles of Prosecco every 28 days.
If, after making these calculations you’re thinking about how you can increase your average order value and / or your purchase frequency then read our blog article on loyalty – starting a loyalty programme can help you boost both of these figures.
Step 4 – calculate your customer value
So, now you’re ready to calculate your customer value for your chosen period of time using the values you have already calculated, your formula will look this:
Customer Value (CV) = Average Order Value (AOV) x Purchase Frequency (PF)
20 x 1.6 = 32
So, using our average order value of £20 and our purchase frequency of 1.6, each customer is worth £32 to us every 28 days.
Measuring your Return on Investment (ROI)
So, based on the time period we’ve chosen, the above formula shows the value of one customer over the period of 28 days, which is already giving us a figure for how much we can reasonably spend on acquiring new customers in that same time period. You can now confidently calculate your ROI for your marketing campaigns because you have a figure for your gain from investment, take a look below:
The formula for calculating your ROI is:
ROI = (Gain from investment – cost of investment) ÷ Cost of investment
So, if your aim is to acquire 1 new customer every 28 days (the customer value you have identified is your gain from investment) you can work out how much you can afford to spend on marketing to acquire that customer without making a loss.
Using our example, and making an assumption that it costs say, £6 to sell each bottle of Prosecco (this £6 figure is just for illustrative purposes – you’ll need to look at your own figures here for what it costs you to sell your product or service), here’s the calculation:
(32 – 6) / 6 = 4.33
So now we know. We can spend up to £4.33 on acquiring new customers to buy Prosecco, or on increasing the frequency with which existing customers buy Prosecco before we make a loss.
You can also calculate your ROI using CLV:
ROI = (Customer Lifetime Value (CLV) – Marketing investment) ÷ Marketing Investment
But how do we work out the lifetime value of our customers?
Calculating Customer Lifetime Value (CLV)
To calculate your CLV there is one more variable you need to work out, and that is the average customer lifespan for your business. If you’re a relatively new business, this variable can be a bit tricky to work out as you need to look at historical customer data. What you need to determine is how long your average customer continues to buy from you before they stop purchasing and falls dormant. You’ll have to look into your own data for this bit!
The average time it takes for a customer to reach this point is the average customer lifespan of your business.
To give you a full example and help you work this out, we’re going to say our customers will take six months to reach this point on average. So we can now calculate our Customer Lifetime Value like this:
CLV = Customer Value (CV) x Average Customer Lifespan (ACL)
32 x 6 = 192
Using the Customer Value figure we calculated before of 32, we can see that each Prosecco customer is potentially worth £192 to us. We can increase that figure by lengthening the ACL, increasing the average order value or increasing purchase frequency.
And now you know what your customer value is, you can plan your next marketing campaign with confidence!
Remember that these calculations look at your average customer. For a deeper understanding you can segment your data and apply the same calculations to different segments. This can help you focus your efforts in different ways to get the most from your marketing – depending on the customers you’re targeting. You could segment your customers by demographic, location, acquisition channel, or behaviour, such as, are they signed up to your loyalty scheme? Then you can really understand your customers and where, when and how you should target new ones.
But, equally important to remember, there are many variables to consider and things change, businesses diversify and grow. So don’t just calculate your CLV once, keep doing it over the coming months and years to make sure you’re maximising your marketing efforts.
We can help you increase your customer lifetime value. Get in touch to find out how.
