Utilizing Customer Lifetime Value & How to Calculate It
Customer lifetime value (CLV) is a popular metric used at SaaS and product companies, but we don’t see it measured as frequently at professional service organizations. We’re big proponents of using CLV as a digital agency KPI as it helps leaders make proactive strategic decisions that support digital services growth and increase the average CLV.
This article discusses the importance of utilizing customer lifetime value (CLV) to improve business operations and performance. It covers how to calculate customer lifetime value before providing four questions that can help digital service companies use CLV to better understand their business and inform strategic decisions.
The key takeaways from this article are:
- Customer lifetime value (CLV) is a critical metric that can help digital service companies improve business operations and performance.
- To measure CLV, it is important to use a formula that accounts for costs so that profit is calculated and not just revenue.
- By bucketing customers and identifying patterns, digital service companies can target prospects and buyer personas similar to their most profitable customers.
- Understanding which types of projects are most profitable can help digital service companies improve CLV across accounts by upselling their most profitable projects to customers that haven’t bought them but could benefit from them.
- Charting customer lifetime value over time can help digital service companies pinpoint when margin typically starts to decline and take action to prevent it.
Table of Contents
- What Is Customer Lifetime Value (CLV)?
- How to Calculate Customer Lifetime Value
- Utilizing Customer Lifetime Value at Your Digital Services Agency
What Is Customer Lifetime Value (CLV)?
Customer lifetime value (CLV) calculates the total profit margin you can expect to earn from a customer throughout their entire lifecycle with your business.
Each company’s average CLV will vary based on average customer lifespan, the services they offer, and how well they retain and upsell existing clients. But there are several ways every digital services company can use CLV to improve business operations and performance.
How to Calculate Customer Lifetime Value
Google “how to calculate CLV,” and you’ll find numerous formulas. One simple way to calculate customer lifetime value is using this formula:
CLV = Average Revenue Per Customer (Annual) × Average Customer Lifespan x Gross Profit Margin
To get even more precise, your business can account for a variety of other factors that impact your CLV, including how likely each customer is to expand their engagement with you. First Page SEO shares a few factors to consider adding to your CLV calculation, including:
- Likelihood (and value) of service expansion
- Likelihood of new customer referral
- Likelihood of reference or case study
Regardless of which formula you use to calculate CLV, it is critical to use one that accounts for costs, so you calculate profit and not just revenue.
Accounting for costs is important because different factors (e.g., the combination of resources you assign to a project) can affect project costs and how profitable a project is. The accounts and projects that generate the most revenue are not always the most profitable.
In a similar vein, profitability alone doesn’t identify your best customers. Some highly profitable customers could actually be your worst customers if they’re toxic or misaligned with the agency’s vision or culture. Profitability isn’t the only data point to identify your best customers, but it is an important one.
Utilizing Customer Lifetime Value at Your Digital Services Company
We want to help you use CLV to better understand your digital agency. Here are four questions customer lifetime value can help you answer to uncover important agency insights that inform your strategic decisions.
1. What types of customers are most profitable?
Not all customers are equal, so not all customers will have the same CLV. Go beyond simply calculating an average customer lifetime value across your portfolio by calculating CLV for each customer. Then, bucket customers into groups based on account similarities (e.g., company size, industry, the job title of executive sponsor) to get an average.
Calculating the average CLV of each customer type can help you identify patterns in your most profitable customers. For example, “our CLV is highest when an IT director at a consumer technology company with 500-1,000 employees hires us to solve a technology challenge.”
These patterns can help you tailor your sales and marketing efforts to target prospects and buyer personas similar to your most profitable customers.
To bucket customers and identify patterns, you need visibility into up-to-date CRM data. If you’ve developed sales operations best practices that keep data fresh, you can cross-check customers against things like the source of lead, company size, decision-maker, NPS score, primary business challenge, and more. You can get as granular or high-level as your business needs.
Reminder: The customers that bring in the most revenue are not always your most profitable customers. High-revenue customers could also have the highest costs that eat into your profitability. Or, depending on where the customer is in their lifecycle, their profit margin could be on the decline. These are all insights that CLV can help you uncover.
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2. What types of projects are most profitable?
Uncovering patterns between your customers with the highest CLV is the first step to identifying your “best” customers. The next is to dig a little deeper to understand how various projects affect customer lifetime value.
If you have a different CLV between two similar customers, explore why that could be. Factors that could affect this include:
- Project type: What kind of service are you providing and which is most profitable? For example, is it a wedge offering, mobile app development, user experience design, or paid media campaign?
- Pricing structure: Are you charging based on the project, a retainer, or time and materials? Which seems to be most profitable for your agency?
- Team makeup: Do you have your best (and most expensive) talent assigned to certain projects but have more junior employees managing others? How is resource allocation affecting profitability?
Digging into the data can help you determine what drives profitability within projects. It can also help you spot which projects are growing and becoming more valuable to customers (or declining and becoming less valuable).
Use this information to improve CLV across accounts by upselling your most profitable projects to customers that haven’t bought them but could benefit from them.
3. When does profit margin typically start to decline?
Chart customer lifetime value over time to pinpoint when margin typically starts to decline. If your average customer lifespan is three years, but margin starts to fall at two years, you can brainstorm ways to improve profitability at this stage.
This may be the right time in the lifecycle to introduce your customers to higher-value services, like the ones you identified as your most profitable projects. You might also realize you have a gap in your service offerings and need to invest in innovation to develop offerings that support customer needs for longer.
4. Which customers can we leverage for innovation?
Utilizing customer lifetime value also helps you pinpoint which accounts have profit wiggle room to test innovative ideas. Let’s say you have a highly profitable customer that isn’t nearing the point in its lifecycle when profitability declines.
You can offer this customer a new service that may not be profitable (yet) but that your team thinks could be a service offering with a lot of growth potential in the future. This customer provides you with a cushioned testing ground to vet the idea and build processes and methods.
The profitability of this account gives you the flexibility to take innovative risks that provide important business insights.
This innovative work is what McKinsey’s 3 Horizons of Growth advocates for in Horizon 2. If you only focus on your most profitable work (Horizon 1), you don’t invest the time necessary into predicting what customers will want from you next.
Agencies risk all of their services becoming commoditized if they don’t consistently wear their “innovation hat.”
Get the Data You Need to Calculate CLV With Parallax
Utilizing customer lifetime value requires real-time access to the data that informs it. It should be easy for your team to quickly identify the revenue and profitability of each customer and the profitability of each service area.
These insights help you determine proactively if a customer or service is becoming more or less profitable, which supports proactive strategic action.
Parallax provides consistent, reliable, and real-time data governance from sales to delivery and beyond so you can easily calculate CLV. Our forecasts give you a view into the future to predict where things are headed with customers, so you can make data-informed adjustments—before it’s too late.
To learn more, book a demo of Parallax today!