Successful Monetization: Customer Lifetime Value & Acquisition Cost – MBA Talent for Hire by GrowWise
CLV is simply the present value of the future cash flows from a customer, over the course of their relationship with your business. We discount the future predicted cash flows using DCF (discounted cash flow) methodology in order to account for the time-value of money and future risk. We previously discussed this concept and the use of net present value in our article Buying vs. Leasing – use Net Present Value!. Basic versions of CLV do not always use DCF, which is typically considered an incomplete approach. As a starting point, however, it’s worth reviewing the more basic frameworks in order to understand the thinking behind CLV.
I. Simple CLV formula (without DCF):
CLV = Avg Annual Gross Profit / Avg Annual Churn Rate.
Gross profit (GP) = average gross profit from a customer = net sales – cost of goods sold (COGS);
Net sales = sales – returns & discounts;
COGS = fixed and variable costs directly tied to the production of the product or service (e.g., the labor and materials directly used to produce the good or service, and not the indirect costs for sales and distribution);
Churn rate (C) = 1 – retention rate (r);
Average Customer Lifespan = 1 / Churn Rate; and
Retention rate (r) = ((Customers at End of Period – Customers acquired during period)/Customers at Start of Period) x 100.
n our article Top 3 Reasons Why New Businesses Fail, we highlighted the importance of understanding Customer Acquisition Cost (CAC), and Customer Lifetime Value (CLV). Optimizing the CLV-CAC relat…