Fundamentals of Customer Lifetime Value for eCommerce

How do you know if your eCommerce business is successful? More often, the answer is tracking sales and cash flow. While these are great metrics to judge short-term performance, they don’t portray a complete view of your business.

Certainly, one of the most important eCommerce metrics that you, as a store owner, should pay more attention to is Customer Lifetime Value (CLV). It measures how valuable your customers are. It provides an estimation of future success rather than just today’s sales.

By calculating the CLV, you will have a close look at the value of your customer. It helps design the customer retention strategy and improve the profit margin. In this blog, you will find out what customer lifetime value in eCommerce is, how to calculate it, and how professionals in eCommerce management increase their business’s CLV.

What is Customer Lifetime Value (CLV) in eCommerce? 

Customer lifetime value, also called CLV/LTV, is a metric that measures customers’ value to a business during their transaction relationship. It evaluates the time and amount spent from their very first to the last purchase.

Knowing your eCommerce customer value is valuable. It gives you an idea of how much you can afford to spend in acquiring new customers and, conversely, how much you can gain from new customer types. It guides where to focus marketing and sales efforts.

CLV calculations give a wider perspective on customer behavior. With this approach, you can better understand how your business generates revenue and identify the areas for improvement.

The standard formula for calculating eCommerce CLV is:

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CLV= Average Order Value (AOV) x Purchase Frequency x Average Customer Lifespan

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• Average Order Value: The average amount of money a customer spends per order.
• Purchase Frequency: The average number of times a customer buys from your business within a given period, such as annually or quarterly. 
• Average Customer Lifespan: The typical length of time a customer continues to engage with your brand.

What is the Average eCommerce Customer Value?

Many eCommerce experts suggest that your Customer Lifetime Value (CLV) should be three times your Customer Acquisition Cost (CAC). This means for every dollar you spend to get a new customer, you should make three dollars in return. A 3:1 LTV ratio is considered healthy and sustainable for most businesses, ensuring long-term profitability.

Why is eCommerce Customer Lifetime Value Important?

eCommerce customer lifetime value helps you understand how much revenue a customer will bring to your company over their relationship duration with you. This insight is invaluable when deciding how much to invest in acquiring new customers.

Instead of just trying to stay afloat, understanding CLV allows you to focus on the right customers. You’ll know which customers bring the most value and why they are important to your business.

Here’s why understanding your CLV is beneficial:

• Drives Repeat Sales and Revenue: CLV helps you identify the customers who perform repeat purchases. Knowing what products they love and how those products enhance their lives is key. You can use this information to pinpoint high-value customers, boost customer satisfaction, and develop strategies to increase the customer retention rate.
• Boosts Customer Loyalty: The eCommerce CLV strategies you implement can also enhance customer support, product offerings, pricing, referral programs, and loyalty schemes. This, in turn, improves the overall customer experience. Loyal customers tend to buy more frequently and spend more than new customers.

Focusing on the right customers is essential for turning a short-term success into a long-lasting brand. However, calculating CLV can be complex. If you’ve tried to figure out your CLV before, you may have encountered confusing formulas.

Fortunately, there are simpler ways to calculate eCommerce customer value without compromising accuracy. While customer behaviors can be unpredictable and appear random, a simplified approach can still provide valuable insights. Some businesses even consider gross margin and operating expenses like cost of goods sold (COGS) and shipping costs in their CLV calculations.

By adopting a straightforward method to determine CLV, you can easily capture a snapshot of your customer journey. This will allow you to make informed predictions about future plans, helping you strategize effectively.

Methods to Calculate eCommerce Customer Lifetime Value

By now, you might be ready to calculate your eCommerce CLV, right? However, you first need to select a calculation method. There are two methods you can choose from based on the available data:

Accumulated Data Method

If you have historical sales data, this method offers greater accuracy for calculating Customer Lifetime Value (CLV). It compiles all orders made by individual customers to determine their unique CLVs. If your business has been operating for a while and you’ve just decided to start tracking CLV, many eCommerce analytics tools can retrieve historical data from day one. The formula is simple:

CLV = Order 1 + Order 2 + … + Order n (n is the total number of orders)

For instance:

Let’s say a customer made three orders over time: $50, $75, and $100.

CLV = $50 + $75 + $100 = $225

Average Estimate Method

If you lack detailed data, you can estimate an average CLV using this formula:

CLV = AOV x n (n is the average number of orders per customer)

This method uses the Average Order Value (AOV) and the average number of orders per customer. It’s useful if you are just starting your eCommerce business and only have industry data. It provides a basic estimate of CLV based on typical customer behavior in your industry.

For instance:

Suppose the Average Order Value (AOV) is $60, and on average, each customer makes four purchases.

CLV = $60 x 4 = $240

How to Calculate Customer Lifetime Value in eCommerce?

Calculating eCommerce CLV is not as complex as you might think. You just need to choose a suitable calculation method for your business and gather some data.

Here’s how to get started:

Use RFM Technique to Segment Customers

Before getting into the nitty-gritty of eCommerce customer lifetime value calculation, let’s cover the basics of analyzing customer value using the RFM technique: Recency, Frequency, and Monetary Value. 

• Recency: It shows how recently the customer has made a purchase. A customer who has bought something recently is more likely to buy again than a customer who hasn’t purchased in a while.
• Frequency: It refers to how often a customer makes a purchase within a certain timeframe. The more often shoppers make purchases, the more engaged and loyal they are than others.
• Monetary Value: It takes into consideration the actual amount of money spent by the customer within a specified period. Those customers who spend the most money are generally considered more valuable because they contribute more towards your revenues.

You can segment your customers from least to most valued using RFM. Using this method, you can analyze each group separately and know which customers are worth focusing on for better lifetime value.

To implement RFM in your customer data, consider three points of information on each customer: the date of their last purchase, the total number of purchases within a set period, and the total amount spent within the same period.

It will also help you collect information that will segment customers accordingly into different classes of recency, frequency, and monetary values. This segmentation helps you spot high-value customers who are most productive and low-value customers who may need special offers to spend more.

Determine the Three Metrics of CLV Formula

As said earlier, the CLV formula is calculated based on three metrics: average order value, buying frequency, and average customer lifespan. After segmenting the customer base, start calculating the value of these metrics:

Average order value: It represents the average amount of money that a customer spends every time they place an order. To get this number, take your total revenue and divide it by your total number of orders.

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Average Order Value = Total Sales / Order Count

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Purchase frequency: It represents the average amount of orders placed by each customer. Using the same time frame as your average order value calculations, you’ll need to divide your total number of orders by your total number of unique customers.

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Purchase Frequency = Total Orders / Total Customers

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Average customer lifespan: It is the length of time that your relationship with a customer typically lasts before they become inactive and stop making purchases permanently.

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 Customer Lifespan = 1 / Churn Rate

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Calculate your CLV

Now that you have these metrics, you can calculate your eCommerce CLV using the formula we defined above.

The complexity of the calculation might vary depending on the industry and the type of eCommerce business. So, we’ll go through different examples to see how this works.

Example 1: Fashion Retail

Imagine you own an online fashion store. Here’s a simple way to calculate CLV:

• Average Order Value (AOV): $50
• Purchase Frequency: 4 times a year
• Average Customer Lifespan: 3 years

Using the formula:

CLV=$50×4×3=$600

So, each customer is expected to bring in $600 over three years. This calculation helps you plan marketing budgets and customer acquisition strategies effectively.

Example 2: Subscription Box Service

If you have implemented a subscription model in your eCommerce store, the calculation might be tough.

• Average Order Value (AOV): $30 per month
• Purchase Frequency: 12 times a year (monthly subscription)
• Average Customer Lifespan: 2 years

Using the formula:

CLV=$30×12×2=$720

The CLV here is $720. This helps in understanding the long-term value of a subscriber and can inform decisions about subscription pricing and customer retention efforts.

Example 3: B2B eCommerce for Office Supplies

B2B eCommerce deals with different customer segments, so calculating the CLV here might get complicated. Let’s understand it with this example:

The business is selling office supplies:

• Average Order Value (AOV): $200
• Purchase Frequency: 6 times a year
• Average Customer Lifespan: 5 years

Additionally, consider variations in customer segments (small businesses and large corporations), which can affect the AOV and purchase frequency:

Small Business Segment

• AOV: $150
• Purchase Frequency: 4 times a year
• Lifespan: 3 years

CLV=$150×4×3=$1,800

Large Corporation Segment

• AOV: $400
• Purchase Frequency: 8 times a year
• Lifespan: 7 years

CLV=$400×8×7=$22,400

For B2B eCommerce, the CLV calculation can be more complex due to the varied customer base. Small businesses might have a lower CLV, whereas large corporations can bring significantly higher value.

How to Increase eCommerce Customer Lifetime Value?

Once you are done with calculating the CLV, you need to make an effective strategy to increase or maintain it.

Here are some proven tactics to improve your eCommerce customer value:

Boost Sales with Cross-Selling and Upselling

Cross-selling and upselling are two selling techniques that can increase your revenues. The former means offering complementary products to a customer already making a purchase. For example, when a fast-food restaurant asks customers if they want fries with a burger or when an eCommerce site shows “customers also bought” suggestions.

On the other hand, upselling encourages customers to upgrade or buy additional features at a higher price. Examples include websites offering free shipping on orders more than a specific amount and an airline offering seat selection at an additional fee.

Both strategies ensure increased average order value, thus better return for your business and customer lifetime value.

Create Unforgettable Customer Experiences

Your customers will either have a great experience or not. Did you know 86% of buyers are willing to spend more for a better experience? However, a poor experience can cause organizations to lose a large opportunity, as 76% of consumers will not purchase after one or two bad experiences with a business.

Consider providing multi-language support and investing in your team’s customer service training. Analyze and work on the customer journey constantly. By doing so, you will be able to retain happy customers and ensure maximum lifetime value.

Reward Your Customers with a Loyalty Program

Loyal customers are invaluable; you should not take them for granted. Try to encourage repeat business by using a brand loyalty program that provides benefits and rewards.

For instance, Starbucks operates a widely popular reward program where customers get stars for every purchase. These stars can be redeemed to get items for free. Order ahead and pay through the app to experience convenience—this kind of program keeps customers coming back and makes their interactions with your brand more enjoyable.

Focus on Customer Feedback

Understanding your customers is probably the most critical aspect of any business. You can continually monitor their feedback on various aspects of needs and concerns related to customer data analytics.

Customers will share their satisfaction or dissatisfaction with the item and on social media comments. Make them feel that you are listening by responding and implementing their suggestions. Also, surveys should be sent to them to gather direct feedback. Then, grievances can be converted into opportunities.

Develop an Omnichannel Strategy

Today’s consumers shop via many different devices and platforms, and they demand access from businesses at every touchpoint. A well-defined omnichannel eCommerce strategy ensures the delivery of quite a consistent and integrated experience to the customers, regardless of their touchpoint in the customer journey.

This strategy aligns all channels to answer the needs of customers: a smooth system with seamless interaction on all lines—phone, web, mobile, email, social media, and physical stores.

Build a Community Around Your Brand

Creating a sense of community around your brand can significantly enhance customer engagement and loyalty. Customers are more likely to stay connected if they feel like they’re part of something bigger than just a sales transaction.

This can encourage social media interaction. You will invite your customers to share reviews and images, use branded hashtags, and create community groups for them to offer advice and opinions. Fostering a community invites engagement and builds stronger, more qualitative relationships with customers.

Grow Your Customer Base with Referrals

Word-of-mouth is a more cost-effective way to acquire new customers than advertisements. An eCommerce referral program incentivizes existing customers to spread the good word about your business to their friends and relatives to extend your reach and customer base.

A strong referral program helps to build goodwill and create positive sentiment about your brand. It rewards your loyal customers for word-of-mouth referrals and gives new customers a reason to try your products or services.

Delight Customers with Free Upgrades

Free upgrades can go a long way toward customer satisfaction and loyalty. Freebies do come with a cost, but in the long run, the payoff is great.

Free upgrades would not only satisfy the customer but also help in getting useful comments on new products or features to bring them to the market.

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FAQs on Customer Lifetime Value for eCommerce

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Final Words

Measuring and improving eCommerce customer lifetime value has become more important than ever. It’s because of increased market competition and constantly growing customer acquisition costs. Research says acquiring a new customer is five times costlier than retaining an existing one.

Of course, you won’t stop attracting new customers to your business, but balancing customer acquisition and retention will ensure success.To increase your eCommerce CLV effectively, you can reach out to our experts!