How to Calculate Customer Lifetime Value to Maximize ROI!

If you’ve gotten to this blog post, you’re a business owner with at least one retail store and you’ve probably read the rest of our “covering your bases” series of blog posts that includes:

Why Is Customer Loyalty Important? 
What Is A Customer Loyalty Program?
Loyalty Program Types
Best Loyalty Program Practices
How to Build a Loyalty Program
How Much Does a Loyalty Program Cost?

If you have already used the information contained in the above blog posts to choose the best loyalty rewards program for your business, then great! We invite you to keep reading to learn about how to calculate your Return on Investment and the Customer Lifetime Value of your shoppers. Using these figures will help you to make wise promotional marketing decisions on all of your future campaigns.

How To Calculate Your Return On Investment (ROI)

A ROI, or Return on Investment, is a direct measure that evaluates the efficiency of a particular investment with consideration to the upfront costs of that investment. Any savvy business owner is going to want to make sure that laying out $X in order to implement a marketing strategy, for example, is going to see a return, i.e. profits, on that investment that are at least equal to or greater than X.

The word “return” always refers to “value” and for the purposes of this article, “return” will mean “revenue generated” and “revenue saved”. By calculating the return, you will see the value (revenue) that your business accrued for each promotional effort you marketed and campaigned.

If this is already sounding complicated, let’s step things back and use a “profit” model. Profit simply is the result of “return” minus costs. If your business generated $1 million in additional revenue and incurred $500,000 in costs, then the profit generated is $500,000.

The formula to calculate the ROI is just as simple in mathematical structure, yet different entirely. The purpose of calculating your ROI is to help you understand the efficiency of an investment, for example, you want to see how efficient your new loyalty rewards program is at increasing your revenue. Typically, this formula is a way for investors—and business owners like yourself—to determine whether they are receiving enough gain to continue investing.

ROI does not measure the total amount of revenue a business generates. ROI measures which metric generated the best “return”. Phew! That was a lot of groundwork, but it was necessary to lay it down so that you’ll have ease wrapping your head around the actual formula.

ROI = net profit ÷ cost of investment

Another simpler way of looking at it is this:

ROI = (current value of investment – cost of investment) ÷ cost of investment

Bear in mind that ROI is not a financial metric, but a percentage (a ratio) and it enables you to be rational in your investment decisions. The ROI will show you the percentage return of every financial effort you make. You will be able to see if your loyalty rewards program generates a 40% return or 60% return, and if your return here is higher than other marketing efforts, you can cut unnecessary spending and pour even more funds into the marketing method that works more.

How To Calculate Customer Lifetime Value (CLV)

The purpose of increasing loyalty and customer satisfaction is to increase the lifetime of a customer. How do you Calculate Customer Lifetime Value, or CLV? At the simplest level, CLV is essentially the length of time the customer patronizes your business versus the average amount a customer spends at your business during that same time frame.

CLV = (average monthly transactions × average order value) × average retention rate in months / number of clients for the period

Watch out! You’re not finished yet! The simple equation above will grossly overestimate the value of a customer because it ignores profit, costs, and the discount rate, all of which you’re going to want to include to make your calculations as accurate as possible. An improved formula would also multiply this figure by the average gross margin. With this new formula, you will be able to tell how much profit you make from a customer rather than how much a customer spends.

CLV = ((average monthly transactions × average order value) × average retention rate in months) × average gross margin / number of clients for the period

Customer lifetime value can greatly inform your return on investment, because CLV provides significant value when it comes to marketing ROI.

This is how you use the two resulting figures you’ve gotten from your ROI calculations and your CLV calculations to stay informed and make better business decisions. We’ll show you an example with real numbers:

Let’s assume you’ve calculated your average customer acquisition cost for your company and it’s $100, but the customer spends $180 so you have a CLV of $80 ($180 – $100 = $80).

In this example, the marketing ROI equation is CLV / acquisition cost = ROI (or) $80 ÷ $100 = 80%. In other words, your marketing department has taken $100 and turned it into $180 by acquiring a new customer, which is an 80% ROI.

There you have it! A little math goes a long way, and now that you are able to calculate the ROI percentage on all of your marketing efforts, you can focus more funds towards the methods that work!

Alternatively, if calculating your CLV and ROI has you feeling overwhelmed, the Loyal~n~Save team is available to assess those calculations for you! It’s all part of our hands-on loyalty strategist services and when you sign up for our digital platform you will receive step-by-step assistance in implementing all of your marketing efforts. Just click here to connect with a Loyal~n~Save Strategist.