{"id":1738,"date":"2021-12-28T15:43:58","date_gmt":"2021-12-28T08:43:58","guid":{"rendered":"https:\/\/mintea.blog\/?p=1738"},"modified":"2021-12-28T15:58:13","modified_gmt":"2021-12-28T08:58:13","slug":"1738","status":"publish","type":"post","link":"https:\/\/mintea.blog\/?p=1738","title":{"rendered":"Simple CLV Formula"},"content":{"rendered":"<p><strong>Simple CLV Formula<\/strong><\/p>\n<p>There are\u00a0<a href=\"https:\/\/www.clv-calculator.com\/customer-lifetime-value-formulas\/\">two main approaches<\/a>\u00a0to calculating customer lifetime value. This article discusses the simple approach to calculating customer lifetime value \u2013 which is appropriate to use when customer profit contribution to each year are relatively flat. It is also a good idea to review the article on the\u00a0<a href=\"https:\/\/mintea.blog\/?p=1741\">full customer lifetime value formula<\/a>, also available on this website.<\/p>\n<p><strong>The simple customer lifetime value formula<\/strong><\/p>\n<p>The simple customer lifetime value formula is:<\/p>\n<p><strong><em>Annual profit contribution per customer X<\/em><\/strong><\/p>\n<p><strong><em>Average number of years that they remain a customer<\/em><\/strong><\/p>\n<p><strong><em>Less the initial cost of customer acquisition<\/em><\/strong><\/p>\n<p><strong>An example of the simple customer lifetime value formula<\/strong><\/p>\n<p>Let\u2019s assume the following:<\/p>\n<ul>\n<li>Profit generated by the customer each year = $1,000<\/li>\n<li>Number of years that they are a customer of the brand = 5 years<\/li>\n<li>Cost to acquire the customer = $2,000<\/li>\n<\/ul>\n<p>The customer lifetime value of this customer would be:<\/p>\n<p>$1,000 (annual profit from the customer) X<\/p>\n<p>5 (number of years that they are a customer) less<\/p>\n<p>$2,000 (acquisition cost) = $3,000 = CLV.<\/p>\n<p><strong>That is, $1,000 X 5 \u2013 $2,000 = $3,000.<\/strong><\/p>\n<p><strong>A more detailed example of the simple CLV formula<\/strong><\/p>\n<p>Let\u2019s look at the same formula to calculate customer lifetime value, the building a little bit more complexity by changing the initial assumptions as follows:<\/p>\n<ul>\n<li>annual revenue per average customer is $2,000 per annum<\/li>\n<li>product costs associated with the average customer\u2019s purchases is $500 per year<\/li>\n<li>the firm also spends $100 a year per customer to provide customer service<\/li>\n<li>annual retention rate (loyalty rate) is 80%<\/li>\n<li>average costs to acquire a new customer are $1,000<\/li>\n<\/ul>\n<p>In this example, we have a similar challenge to the example above, but the information is not presented as neatly and we need to modify some of the above data to feed into the customer lifetime value formula.<\/p>\n<p>Our first step here is to calculate the average annual profit per customer \u2013 which is determined by deducting the two sets of costs (product costs and service costs) from the annual revenue. In this case, it is $2000 \u2013 $500 \u2013 $100 = $1,400.<\/p>\n<p>We have acquisition costs provided for us ($1,000), but unfortunately we do not have the average lifetime of the customer in years \u2013 we only have the annual retention rate. This will be a common situation in a workplace, as it is relatively easy from a customer database to calculate retention rates. So our challenge is now to convert a retention rate to the average number of years that the customer will deal with the firm.<\/p>\n<p>There is another article on\u00a0<a href=\"https:\/\/www.clv-calculator.com\/customer-retention\/converting-retention-rate\/\">converting retention (loyalty) rates to an average customer lifetime period<\/a>. However, it is quite easy to calculate the customer lifetime in years from a retention rate, as follows:<\/p>\n<p><strong><em>100% divided by (100% minus the annual retention rate)<\/em><\/strong><br \/>\n<em>OR (1 \/ 1- annual retention rate)<\/em><\/p>\n<p>So in this example of an 80% loyalty rate, the average customer lifetime would be:<\/p>\n<p>100% \/ (100% -80%) =<br \/>\n100% \/ 20% = 5 years average customer lifetime period<\/p>\n<p>Now we have all the inputs into the simple customer lifetime value formula, we can then calculate CLV as:<\/p>\n<p><strong>CLV = $1,400 (profit) X 5 (years) \u2013 $1,000 (acquisition) = $6,000<\/strong><\/p>\n<h1>When to Use the Simple CLV Formula<\/h1>\n<p>&nbsp;<\/p>\n<p>There are two customer lifetime value (CLV) formulas provided on this website. This article discusses when it is appropriate to use the\u00a0<a href=\"https:\/\/www.clv-calculator.com\/customer-lifetime-value-formulas\/simple-clv-formula\/\">simple customer lifetime value formula<\/a>.<\/p>\n<p>You may also want to refer to the\u00a0limitations of using this formula\u00a0and you should also review the article on main customer lifetime value formula. Please note there are also a\u00a0<a href=\"https:\/\/www.clv-calculator.com\/free-clv-excel-templates\/\">free Excel spreadsheet template<\/a>\u00a0available on this website that allows you to calculate customer lifetime value.<\/p>\n<h2>When to use the simple CLV formula<\/h2>\n<p>The simple CLV formula is quite appropriate to use when:<\/p>\n<ul>\n<li>Retention rates of customers are relatively low (say 50% or less) \u2013 which means of most of the customer profit contribution is received in the first few years<\/li>\n<li>Profit contributions from customers are relatively flat over time \u2013 that is, there is no significant changes in the average customer profitability with time<\/li>\n<li>The data inputs to the model are mainly based upon assumptions rather than historical customer data (with the customer lifetime value just being a rough estimate)<\/li>\n<li>Only a ballpark customer lifetime value estimate is needed \u2013 rather than a precise measure<\/li>\n<li>The firm is uninterested or uncomfortable in using discount rates<\/li>\n<li>Customers are highly profitable and recover their acquisition costs within the first year<\/li>\n<\/ul>\n<p>&nbsp;<\/p>\n<h3>How accurate is the simple CLV formula?<\/h3>\n<p>In many cases, the simple customer lifetime value formula is quite adequate and will provide a reasonable estimate as compared to the main CLV formula (which is available on the\u00a0<a href=\"https:\/\/www.clv-calculator.com\/free-clv-excel-templates\/\">free Excel spreadsheet template<\/a>\u00a0on this website).<\/p>\n<p>There are two key differences between the simple CLV and the main CLV formulas are:<\/p>\n<ul>\n<li>The simple customer lifetime value formula assumes that all the data inputs (customer revenue\/costs and retention rate) remains consistent over time, and<\/li>\n<li>The simple CLV formula does not use a discount rate.<\/li>\n<\/ul>\n<p><strong>Let\u2019s compare the calculations of both CLV formulas using an example as follows:<\/strong><\/p>\n<p>A firm has an average acquisition cost of $500, average customer annual profit contribution is $800 \u2013 which increases by 5% per year, and the firm\u2019s retention rate is 60% (equivalent to 2.5 years average lifetime). In this case, a 10% discount rate is used in the main CLV formula.<\/p>\n<p>Using the simple CLV formula:<\/p>\n<ul>\n<li>CLV = $840 (customer profit contribution \u2013 see note below) X<\/li>\n<li>2.5 (average customer lifetime in years) \u2013<\/li>\n<li>$500 (Customer acquisition cost)<\/li>\n<li>CLV = $2,000 \u2013 $500 = $1,600<\/li>\n<\/ul>\n<p>NOTE: In this case, we have used $840 in annual customer profit contribution. While the customer profit starts at $800, it increases by 5% pa \u2013 so profit becomes $840 in year 2 and then $882 in year 3, and so on. Because the customer lifetime period s only 2.5 years, the 2nd years\u2019 profit has been used as the approximate average customer profit.<\/p>\n<p>Using the\u00a0<a href=\"https:\/\/mintea.blog\/?p=1741\">main CLV formula<\/a>\u00a0(using the\u00a0<a href=\"https:\/\/www.clv-calculator.com\/free-clv-excel-templates\/\">free Excel template<\/a>):<\/p>\n<p>CLV (before discounting) = $1,660<\/p>\n<p>CLV (after the discount rate) = $1,201<\/p>\n<h4>THEREFORE, A CLOSE APPROXIMATION WITHOUT USING A DISCOUNT RATE<\/h4>\n<p>As you can see, before the applicable of the discount rate, both CLV figures are very close in value \u2013 $1,600, as compared to $1,660 using the template (without using the discount rate).<\/p>\n<h4>HOWEVER, SIGNIFICANT DIFFERENCES WHEN USING A DISCOUNT RATE<\/h4>\n<p>As you can also see, once the\u00a0<a href=\"https:\/\/www.clv-calculator.com\/discount-rates\/\">discount rate<\/a>\u00a0is applied, there is a significant difference between the two formulas \u2013 $1,600 as compared to $1,201.<\/p>\n<p>Therefore, the\u00a0<a href=\"https:\/\/www.clv-calculator.com\/customer-lifetime-value-formulas\/clv-formula\/\">main customer lifetime value formula<\/a>\u00a0(or\u00a0<a href=\"https:\/\/www.clv-calculator.com\/free-clv-excel-templates\/\">Excel template<\/a>) should be used if:<\/p>\n<ul>\n<li>The firm normally uses a discount rate<\/li>\n<li>The retention rate is quite high (that is, more than 75%)<\/li>\n<li>There are significant changes in the customer revenue and\/or costs over time<\/li>\n<\/ul>\n<p><strong>Advantages and Limitations of the Simple CLV formula<\/strong><\/p>\n<p>As discussed on this website, there are two approaches to calculating customer lifetime value. The first approach is to use a relatively simple formula \u2013 which is discussed in detail with examples in the article on the\u00a0<a href=\"https:\/\/www.clv-calculator.com\/customer-lifetime-value-formulas\/simple-clv-formula\/\">simple CLV formula.<\/a><\/p>\n<p>The other approach is a little bit more complex and is best calculated using the<a href=\"https:\/\/www.clv-calculator.com\/free-clv-excel-templates\/\">\u00a0free Excel template<\/a>\u00a0available on this website. However, details and examples on using this CLV formula discussed under the article on the main\u00a0<a href=\"https:\/\/www.clv-calculator.com\/customer-lifetime-value-formulas\/clv-formula\/\">CLV formula<\/a>.<\/p>\n<p>It is this second approach that is generally recognized as the formal and more accurate approach to calculating customer lifetime value. But it is a little bit cumbersome to calculate and generally does require the assistance of an Excel spreadsheet. Therefore, there are times when\u00a0<a href=\"https:\/\/www.clv-calculator.com\/customer-lifetime-value-formulas\/simple-clv-formula\/use-simple-clv-formula\/\">using the simplified customer lifetime value formula is more appropriate<\/a>\u00a0and\/or more efficient.<\/p>\n<p><strong>The main advantages of the simple customer lifetime value formula are:<\/strong><\/p>\n<ul>\n<li>It can be calculated very quickly and simply,<\/li>\n<li>It can be more easily explained to management, allowing you to more efficiently communicate the concept of customer lifetime value and how it relates to financial and corporate objectives,<\/li>\n<li>It is generally reliable for short-term customer loyalty situations<\/li>\n<li>It is also generally reliable where annual customer profit contributions are relatively flat,<\/li>\n<li>It can be effectively used as a relative measure for tracking customer lifetime value trends over time, and<\/li>\n<li>You can be utilized for comparing the (profit) value of different customer segments.<\/li>\n<\/ul>\n<p><strong>The main limitations of the simple CLV formula are:<\/strong><\/p>\n<ul>\n<li>It does not measure changing customer revenue and costs over time \u2013 making it inappropriate for a firm that is pursuing share-of-customer marketing goals,<\/li>\n<li>It assumes that the retention rate (loyalty rate) is stable and does not change over time \u2013 again making inappropriate for firms pursuing increased loyalty marketing goals, and<\/li>\n<li>It does not apply a discount rate to future customer revenue and costs, resulting in customer lifetime value being overstated to the firm.<\/li>\n<\/ul>\n<p><strong>Which CLV formula to use?<\/strong><\/p>\n<p>As discussed in the article of\u00a0<a href=\"https:\/\/www.clv-calculator.com\/customer-lifetime-value-formulas\/simple-clv-formula\/use-simple-clv-formula\/\">when to use the simple CLV formula<\/a>, this more straightforward formula is appropriate in certain situations. However, as an organization moves towards more professionalism and a greater focus on marketing ROI, the<a href=\"https:\/\/www.clv-calculator.com\/customer-lifetime-value-formulas\/clv-formula\/\">\u00a0full customer lifetime value formula\u00a0<\/a>should be utilized \u2013 which is available by using the\u00a0<a href=\"https:\/\/www.clv-calculator.com\/free-clv-excel-templates\/\">free Excel template<\/a>\u00a0on this website.<\/p>\n<p>&nbsp;<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Simple CLV Formula There are\u00a0two main approaches\u00a0to calculating customer lifetime value. This article discusses the simple approach to calculating customer lifetime value \u2013 which is appropriate to use when customer profit contribution to each year are relatively flat. It is also a good idea to review the article on the\u00a0full customer lifetime value formula, also &hellip; <a href=\"https:\/\/mintea.blog\/?p=1738\" class=\"more-link\">Continue reading <span class=\"screen-reader-text\">Simple CLV Formula<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":1674,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[25],"tags":[32,63,62,55,56,26,54],"class_list":["post-1738","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-bookmarked-articles","tag-analytic","tag-clv","tag-crm","tag-customer-analytic","tag-customer-lifecycle","tag-data","tag-data-mining"],"_links":{"self":[{"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/posts\/1738","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/mintea.blog\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=1738"}],"version-history":[{"count":4,"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/posts\/1738\/revisions"}],"predecessor-version":[{"id":1747,"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/posts\/1738\/revisions\/1747"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/media\/1674"}],"wp:attachment":[{"href":"https:\/\/mintea.blog\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=1738"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/mintea.blog\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=1738"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/mintea.blog\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=1738"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}