Customer Lifetime Value (CLV) is a prediction of the total revenue a business can derive from a customer over the duration of their business relationship. It’s one of the most important metrics for a marketplace because it provides an estimate of the financial value each customer brings over the long-term.
How to calculate it
To calculate CLV, you'll need a few pieces of data: the average purchase value, the average purchase frequency rate, the customer value, and the average customer lifespan. Each involves its own formula:
1. Average Purchase Value: Calculate this by dividing the company's total revenue in a time period (usually one year) by the number of purchases over the course of that same period.
2. Average Purchase Frequency Rate: This is calculated by dividing the number of purchases over a time period by the number of unique customers who made purchases during that period.
3. Customer Value: Calculate this by multiplying the Average Purchase Value by the Average Purchase Frequency Rate.
4. Average Customer Lifespan: This is typically calculated by averaging the number of years a customer continues purchasing from the company.
5. Finally, the CLV can be calculated by multiplying the Customer Value by the Average Customer Lifespan.
Let’s use a hypothetical online marketplace for vintage records as an example. Suppose that in the past year, the store's total revenue was $1,000,000, generated from 20,000 purchases. This puts the Average Purchase Value at $50. During the same period, there were 5,000 unique customers, making the Average Purchase Frequency Rate 4 (20,000 purchases divided by 5,000 customers). The customer value would then be $200 ($50 * 4).
Average lifespan might be harder to ascertain. Say, after checking the historical data for the same customers, you've found that customers stay with the company for an average of 7 years. Hence, the CLV per customer would be the customer value ($200) times the average lifespan (7), or $1,400.
The bottom line
Understanding the CLV helps a marketplace forecast revenue and plan its marketing budgets effectively. It's crucial to remember that increasing the value of each customer can be just as useful in a growth strategy as attracting new customers. By focusing on strategies to boost the CLV like encouraging repeat business and improving customer satisfaction, marketplaces can optimise their growth and profits in the long run.
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