What is CLV? And why is it important to calculate it?

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Summary

Customer Lifetime Value (CLV or LTV) is an estimate, over a defined period, of what a customer can bring in.
In a subscription business, it’s a projection, over a limited period, of the number of subscribers and booking 📈. This is a calculation to be made each time my actions influence the number of subscribers, the Retention rate (RR%) and/or the average selling price (ASP).
Knowing the CLV of each change helps me make an informed decision about customer acquisition and retention strategies, marketing spend, and product development.

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1. What is a CLV in real life?

The more transactions customers carry out with me, the more my booking increases, the more important these customers become.💶 As long as I keep my clients, I can capture part of their budget. These customers have a long-term value called Customer Lifetime Value (CLV).

Let’s take a simple example to understand the concept:

I sell baby diapers. Each baby will wear diapers until around 3 years old, 8 per day for the first few months and one per day for the last few months. On average this will be around 4 per day at € 0.50 each.
3 x 365 days x 4 diapers/days x € 0.50 = € 2190.
A baby has a CLV of € 2190 over 3 years. The CLV is calculated over 3 years since beyond that, the baby no longer wears a diaper, its value no longer increases.

Whatever my role is, I always have the same approach regarding CLV:

• If I sell only premium diapers, I seek to build customer loyalty to capture the maximum of the CLV. The customer must not go to competition.
• If I have a multi-brand approach, I seek to optimize the CLV upwards while planning a fallback offer. It’s better to keep a customer with a lower CLV than let him/her go to competition.
• If I operate the point of sale (POS), I try to increase CLV by selling peripheral products like baby food and avoid purchases at a competitor’s POS.

The CLV is a theoretical value; my goal is to capture it as much as possible while improving it. CLV improvements are made through cross-sell 🍼 🧸and up-sell .

2. What’s special about subscription’s CLV?

In a subscription business, the notion of recurrence is central: there’s an acquisition and renewals as long as the customer remains subscribed. I don’t know how long my customers will remain subscribed, I cannot calculate a precise CLV. However, I can use the CLV as a method of relative measurement between several options.

If I consider a change, I do an A/B test. With the test results of each tested scenario , I make a CLV calculation. The CLV of Control is my reference and I compare it to the CLV of each option.

Whenever I consider a change, I need to know its long-term impact. The CLV is a projection over 3 or 4 years in order to include the effects of several renewals.

3. When and how do I calculate a CLV?

I calculate the CLV each time I voluntarily decide on a change that affects one of the three parameters: the number of subscribers (subscribers), the retention rate (RR%) or the average selling price (ASP).

As I know the current values of these three parameters, I calculate a CLV including several renewals. This is my reference value.
Then, for each alternate scenario, I estimate variations on one or more of these three parameters. I get a CLV for each of these options.

I compare the effectiveness of my different strategies. Then, I can take an educated decision, based on tangible data, over the long term.

Still not convinced? Too abstract?

As in my previous article, I shown carried out a price elasticity test aiming to find out the optimum in acquisition.

Table #1: Results of an acquisition test

Challenger #2 is the best option for volume, Challenger #3 for booking. However, from Control to Challenger #3, we sacrifice nearly 600 units to gain only € 400.

Is this sacrifice profitable in the long term?

To answer this, I calculate the CLV over 3 years for each option according to the conditions in table #2 below:
The renewal price will be equal to acquisition price
My clients are very price sensitive, their retention rate varies by +0.5 points, when the price drops by €3 and -0.5 points when the price increases by €3

Table #2: RR% and ASP by product for next years

As initial values, I re-use the data (units and booking) from the acquisition test (table #1). Then, I use the above RR% and ASP for the subsequent years.

Table #3: Units & Booking each year.

In the last column of the table above, I read the CLV of each option which is the sum of the bookings over 3 years. The other grey column is interesting as it gives the number of subscribers left after 3 years.

Under the chosen conditions,

• Challenger #3 is better in acquisition (year 1) but not in the long term.
• Challenger #2 is the best option in volume due to a higher number of units associated with a higher conversion rate.
• Control is the best option in terms of booking. Compared to Challenger #2, we’re short of 100 units but made € 48k more.

If the ideal solution, where volume and booking increase, doesn’t present itself, it will be necessary to arbitrate between the two. In my Acquisition example (Table #1), Challenger #3 requires sacrificing 600 subscriptions for a gain of €400 or €0.66 per unit. If my cost of acquisition per unit is higher, then this option isn’t good.

Key Takeaways

1. In a subscription business, a CLV calculation is crucial before making any changes affecting any of the 3 key parameters.
2. A CLV should include all costs: for instance, before making a price increase, I must include additional costs at Customer Support due to increased number of calls or customer satisfaction score.
3. A CLV calculation cannot be read absolutely or directly. For example, it’s necessary to validate that a sacrifice in units is worth the benefit in booking by comparing it to the cost of acquisition.