Calculating customer lifetime value

1

Step 1: Calculate net sales per customer, M

Net sales = Sales - discounts, returns and allowances / total customers 2

Step 2: Determine retention spending per customer, R

3

Step 3: Subtract these two to get Contribution Margin per Customer

4

Now perform the CLV calculation on a customer cohort acquired in a given

period (Month 1)

5

Customers in Month 1 (24)

Multiply (M-R) by Total Customers in Month 1 to Get Total Net Profit:

6

Now, factor in customer churn.

You will likely lose some customers between Period 1 and Period 2. The percentage of customers you keep is the retention rate. For each subsequent

period, we multiply customer count by the retention rate, like so:

7

Customers in Month 2(0.8 * 24 = 19)

Assume a retention rate of 80%. Repeat calculation for Month 2.

8

Repeat calculation for Month 3, again reducing customer population by retention rate.

Customers in Month 3(0.8 * 19 = 15)

9

Remember what we’re doing here.

We’re calculating the present value of future cash flows from these customers. So we want to do this calculation for month after month after month, up to

infinity...like this:

10

Month 1

Month 2

Month 3

Extend this calculation to infinity...

The problem: That would take forever to do by hand.

So you use the following calculation, which takes Net Profit and Multiplies it by a long-term multiplier:

12

Long-term multiplier(where d is discount rate and r is

retention rate

Contribution margin per customer

13

14

There you have it.Read more about CLV at my blog, sandranoonan.com.