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The Ultimate Guide to CLV in Ecommerce

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If you have no idea what Customer Lifetime Value means, then it’s high time you did. ⌛️ A lowdown follows on what CLV means and how its calculation and calibration are crucial to boosting your bottom line and staying ahead of the competition. What business owner wouldn’t want to know that?

CLV Defined

Put simply, CLV is the estimated total worth of a customer to a business over the entire life of the relationship.

Let’s use the example of an e-com store that sells 100 tennis balls per year at $1 each for ten years to a customer with an initial outlay of $5 to get the first sale. The profit would be $100 per year over ten years, reaching $1000 minus the money spent to acquire the customer ($5), and an actual net CLV of $995. 

But we need a more precise formula:

Lifetime

By lifetime, we mean the amount of time a given customer will remain active on our platform. KPIs can be employed to see how we are doing in terms of retaining our customers on our platform and engaged in our product or service offering:

👉  Customer activity rate, or purchases in e-commerce, helps us to keep track of lifetime expectancy.

👉  Churn is the percentage of customers that stopped using our company’s product or service during a certain time frame.

👉  With cohort analysis, patterns or changes in consumer behavior throughout the customer experience can be identified.

Purchase Frequency

Purchase frequency is how often a customer purchases in a specific unit of time. It is a measure of activity and retention over certain periods. Purchase frequency metrics can be combined with time-between-purchase and repeat purchase rates to obtain a comprehensive view of our operational performance.

So, for existing customers with a consistent purchasing pattern, time-between-purchase can help us to calculate the purchase frequency without waiting for a full period of time to elapse.

By tracking our repeat purchase rate, we can examine our early life churn and take action from the onset.

Average Order Value (AOV)

We can track AOV through metrics such as price per unit, number of units per order, as well as up-sell and cross-sell rates.

We then have our basket size and we can expand it through activities such as cross-sell or increased selection and price per unit metrics, which can then in turn, be impacted by revenue-management and upselling.

Minimum order quantity, free shipping threshold and volume-based discounts are often used to manage AOV in e-commerce.

Profit Margin

Profit margin is calculated as the ratio of profits, or revenues minus costs, to revenue. While it can provide an indication on how to use our capital wisely, we must clarify how and where we allocate costs and revenues.


The Art Of Segmentation

Customer segmentation is a powerful ally. We divide and organize customers into niche groups based on similarities using characteristics like gender, age, demographic, browsing behavior or spending habits.

In e-commerce, if we can understand how CLV varies by traffic source, we can better decide on our marketing outlay. Where did our budding-Federer find us in the first place for that order? We therefore gain visibility on different customer segments.

By using advertising settings targeted according to demography and interest, we can estimate our CLV per target advertising segments. With details on the acquisition cost and CLV by segment, we can optimize our targeting settings and focus our marketing budget on customer segments that have the greatest return on investment.

First-order content analysis enables us to calculate CLV based on the offering. If we expand on our product category offering, does it affect the CLV of new customers?

We can also sort or group our customers according to their behavior using RFM (recency, frequency and monetary) value. It gives a measure of the value of each segment of our customer base. RFM works by assigning a score to each of the different customers for each of the metrics. The highest score would be then the most desired outcome, e.g. most recent, most frequent and highest value.


So We Know Now What CLV Is… But How Can We Use It?  

Customer Acquisition

According to HBR, CLV directly affects and determines our spend on customer acquisition. It is estimated that it is 5-25 times more expensive to acquire a new customer than it is to retain an existing one.

It would be disastrous if our Cost per Acquisition (CPA) were greater than our CLV. Through insight on CPA and CLV, we can gauge which customer profiles are not profitable or sufficiently profitable to guide our customer acquisition efforts (and costs!) towards the right profiles.

“Think about the customers you want to serve up front and focus on acquiring the right customers. The goal is to bring in and keep customers who you can provide value to and who are valuable to you.”

Jill Avery, Harvard Business School

Optimized Retention Offers

If we fully comprehend the drivers of our customer lifetime values and their expectations, we can optimize our retention offers. We have insight into how to balance the cost of offering a retention offer with the expected remaining lifetime value of the customer.

Financing

We could obtain financing by calculating CLV since we can estimate our future expected earnings for each customer we acquire.


How To Boost Your Bottom Line

💰 Improve Your Cost Structure

It sounds pretty simple, but always try to improve your cost structure since profit margins are a definite driver for CLV.

💰 Establish Effective Retention Strategies

A correct on-boarding may reduce early life churn. It is essential to understand any potential causes of dissatisfaction and resolve them or even offer a discount on a first re-order. When possible, a subscription offering can be set up to retain and increase the purchase frequency of certain types of customers. But not all companies take on retention effectively. Average customer retention rate varies across industries. According to Mixpanel’s 2017 Product Benchmarks report, for most industries, the average customer retention rate was below 20%.

💰 Stretch/Expand Your Offering

Stretching your product or service offering along with on-time availability is a must. Increasing the selection of purchasable items leverages conversion rates.

💰 Proper Communication Strategy

Customer experience is critical: it is your customers’ overall perception of their experience with your business or brand.

In e-commerce, there are specific optimum customer experience drivers:

👉 Easy-to-use websites that actually work

👉 Quality products with reliable descriptions

👉 Quickly trackable, correctly estimated deliveries

👉 Out-of-this-world customer service

Membership programs can be used to improve CLV by making customers more retentive, or can increase their frequency and average order values.

💰 Remember, Communication is King!

Any and all types of communication ultimately impact CLV and need to be managed. Don’t produce nudge-fatigue by over-emailing tennis fans in winter!

We need to get personal to be truly relevant. By personalizing our communications, we engage and provide a more meaningful experience and this could convert into actual purchases.


Forecast or Plan – What’s The Best Option?

Forecasting is when we make a prediction employing a statistical method or an algorithm. Forecasting is preferable when we understand the CLV of numerous customer segments and there is sufficient historical data to comprehend CLV evolution.  There should be no structural changes expected to CLV, its evolution is incremental and can be estimated using forecasting models. 

Planning is preferred when we need to plan lifetime value for a finite number of customer segments, there are limited data on CLV evolution over time, and a more assumption-based approach is required.  Planning is also preferable when there are structural changes envisaged in the lifetime value.

A mix of planning and forecasting may also be appropriate.


Calculating & Tracking CLV

If you’ve got this far, but calculating and tracking your own CLV appears daunting, have no fear, since there are various tools and solutions on the market designed to help you leverage your data. These tools include software like RetentionX – an out-of-the-box solution that converts data into clearer actions. It can not only help you to keep track of your CLV, but also improve and fine-tune it.


CLV Takeaway

With a full picture of our CLV, we are better equipped to make decisions on customer acquisition and retention strategies and put a value to our overall business. We can better CLV by optimizing cost structure, establishing a retention strategy, stretching and expanding on our product or service offering and using proper communication. CLV is powerful, but not the be-all and end-all metric to achieve success. But, in the changing face of competition, for those that are truly CLV-savvy, it’s game, set and match!

 

 

Sources:
Susan Li, „What’s a Customer Worth? Modelling Customers Lifetime Value For Non-Contractual Business with Python“
Julien Kervizic, „ON customer lifetime value in ecommerce“

SaaS expert operating at the interfaces of business, data and technology – Head of Implementation at Personio, Europe's leading HR software.

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