Customer Lifetime Value (CLV) is the net profit gained from the entire relationship with a customer: past, present, and future.
Many companies are just starting to think about CLV. If they are measuring it, they might not be using this powerful metric to its full potential. Many companies (even those with internal data science teams) are also measuring it incorrectly. We have identified five of the most common mistakes made by companies when attempting to calculate and use customer lifetime value to make business decisions below:
- You’re Using a Simple Formula to Calculate CLV
Today you can find a variety of online resources that say you can calculate CLV using three or four variables, such as average order value, overall customer retention rate, and average margin. A methodology using these variables returns just one number – customer lifetime value for the “average” customer. This leads into mistake number two below…
- You’re Using a Single “Average” CLV Number
After you’ve used one of these “simple” online formulas to find your average CLV, you’ve effectively lumped large numbers of one-time buyers in with loyal repeat shoppers. This will not only give you an inaccurate number, but it will not allow you to practice smart segmentation in your marketing efforts.
- You’re Assuming Customer Behavior is Linear
Many companies make the incorrect assumption that if a customer made three purchases last year, she will make three purchases again this year. As a result, many CLV forecasts take on a linear appearance, when in fact they should show a dropoff, as shown below.
- You’re Only Using Historical Data
There is no doubt that historical data is essential to arriving at a useful CLV, and nothing is a better predictor of future behavior than past behavior. However, customer behavior inevitably varies over time, and any predictive model that doesn’t account for this variability should be rejected.
- You’re Using the Bad Inputs from Above to Make Marketing Decisions
If you’re using CLV numbers at all to make decisions about budgeting as well as acquisition and retention strategies, you are already well ahead of many companies who are still using metrics like cost per acquisition and net promoter scores alone to measure marketing success. However, if you’re using inaccurate CLV calculations, you’ll likely make poor decisions when it comes to acquisition and retention strategies.
Want more information about how you can improve your methodology for calculating CLV? Download the full marketing brief: 5 Things You Might be Getting Wrong About Customer Lifetime Value.