How do you calculate CLV? There are various approaches but here is a simple way to calculate customer retention equity or CLV:
- Determine the average retention rate of your customer base.
- Compute the average expected duration of a relationship with a customer using this retention rate.
- Determine the average per period margin and costs that are associated with retaining this customer.
- Multiply the period net profits by the number of periods the relationship lasts.
Here’s an example:
- Suppose for the past four years your retention rate for a set of customers has been 60%, 61%, 62%, and 61% over a 4 year period. This equates to an average retention rate of around 61% (i.e., 61 = (60+61+62+61) / 4).
- Analysis reveals that the expected relationship duration for the average customers is 1/(1-average retention). (1/1.61). In this case that is 2.56 years.
- After analyzing the historical data over the same 4 year period, the firm has determined that the average margin is $7500 and the average costs over this period $750. This equates to a net margin of $6750
- Expected retention equity is $17,280 ($6750*2.56).
Calculating customer retention equity demonstrates why it makes sense to invest in keeping customers. It’s a very interesting way to get a handle on your customer portfolio and to segment your customers. By improving revenue per customer and customer retention, while lowering cost to acquire and serve, you can positively impact CLV.