The customers are what makes each business what it is. That’s why it’s important to understand the value of each one of your customers and identify the projected revenue they generate for your business. This is possible when you use the customer lifetime value formula.
Once you’ve masted the process of customer acquisition and customer retention, it’s time to learn how much money your business will get back after investing in your customers. When it comes to restaurant businesses, calculating the CLV can be tricky compared to businesses like gyms. This is because restaurants don’t require customers to sign long-term contracts.
For a restaurant, the customer lifetime value can’t be directly maximized. Instead, the CLV is driven by approximations such as order frequency, average order cost, and party size.
Customer Lifetime Value Formula: What Is It?
To calculate CLV, you need to use the customer lifetime value formula.
The CLV formula is:
CLV = (Average Transaction Size) x (Number of Transactions) x (Retention Period)
Every business strategy will have some kind of impact on your customer’s lifetime value. For example, price increases may improve the overall average transaction size; however, it may lead to customers visiting your restaurant less frequently.
It’s important for a business to understand how marketing efforts can directly influence CLV. These efforts include product, place, price, and promotion; otherwise known as the four P’s of marketing.
Key Takeaway: Understanding how to calculate the customer lifetime value will allow your business to determine what each customer brings to the company.
How To Calculate CLV
There are different factors that contribute to customer lifetime value, and it’s important to consider them before using the CLV formula.
The CLV factors include:
- Average transaction size
- Average party size
- Average visits per year
- Restaurant profit margin
The formula to use to calculate a restaurant’s customer lifetime value is:
Restaurant CLV = (Average Spend Per Month) / (Monthly Customer Churn Rate)
In marketing, customer churn refers to the number of customers that stop engaging with your business during a specific time period. If a customer doesn’t ever come back to your restaurant, they have churned.
To add numbers to the equation, if the average spend per customer each month is $20, and the percentage of customers that never return is 10%, then the restaurant customer lifetime value is $200.
Restaurant CLV = $20 / 0.10
Restaurant CLV = $200
CLV Calculation Example
To better understand the customer lifetime value formula, let’s look at another example. A pretend restaurant, Dan’s Subs, want to calculate the lifetime value of a customer.
The average order size for the restaurant is $30, and the average customer will visit them two times a week for four months. The lifetime value of this customer is calculated as follows:
Lifetime Value = $30 × 2 × 4
Lifetime Value = $240
After you calculate the cost of goods sold, marketing costs, restaurant overhead expenses, and administrative expenses, Dan’s Subs has a profit margin of 20%.
Customer Lifetime Value = $30 × 2 × 4 × 20%
Customer Lifetime Value = $240 × 20%
Customer Lifetime Value = $48
The calculation above shows the customer lifetime value of the average customer at Dan’s Subs is $48. This is less than the lifetime value of the customer that was calculated above. As a restaurant owner, this value can be used to predict cash flow and understand how many customers you need to acquire and retain in order to reach your profit goals.
2 Factors That Contribute to Customer Lifetime Value
As a business owner, it’s also important to pay attention to how the customer perceives your brand. The average customer should be loyal to your brand as it can impact your CLV. This is why you should pay attention to the factors that contribute to customer lifetime value.
1. Churn Rate
The churn rate refers to how often customers stop coming to your business. This can differ from business to business based on the competitive advantage your company has. For example, startup companies will likely have a larger attrition rate.
To calculate the churn rate of your business, start by following the formula below:
Churn Rate = (Customers at the Beginning of a Period) - (Customers at the End of a Period) / (Customers at the Beginning of the Period)
For example, if your restaurant started with 2,000 loyal customers at the beginning of the year and ended with 1,500 loyal customers at the end of the year, the churn rate would be 25%. This means that 25% of your customers took their business somewhere else.
2. Customer Loyalty
It’s important for a business to have loyal customers. One way to do this is by starting a loyalty program for your business. Brand loyalty can result in an increase in guest retention and a decrease in churn.
6 Ways On How To Increase CLV
Many businesses will look into ways to improve their customer lifetime value.
Below are six ways to increase CLV for your business.
1. Customer Loyalty or Rewards Programs
A customer loyalty program, such as a restaurant loyalty program, is a way for your business to engage and reward frequent customers. This is possible through restaurant punch cards or a points system.
Incentivizing customers will incline them to come back on a regular basis. This increases the times they visit and make a purchase from your business.
2. Upselling and Cross-Selling
Two commonly used marketing tactics are upselling and cross-selling. These strategies encourage customers to purchase multiple items or more expensive items at one time compared to a lower-cost option.
3. Customer Experience
Your business’s brick and mortar location, eCommerce website, and call center are all part of the customer experience. Businesses that provide customers with an enjoyable experience are likely to see customers return for repeat business.
4. Invest in Technology
These days technology helps businesses more than ever and this includes restaurant technology. In fact, many restaurants are keeping up with the latest restaurant technology trends in order to stay ahead of the competition.
Such technology allows businesses to automate processes and track business data. Most business software will allow companies to handle different kinds of data all in one place. This makes it easy to improve business operations such as restaurant operations.
5. Customer Engagement
Engaging with customers helps build brand and customer loyalty while improving the customer experience. This is possible through advertising, sales, and customer support.
6. Improved Customer Service
Good customer service can increase your customer lifetime value while also improving customer loyalty. This is possible through customer relationship management or CRM systems.
These allow for customer service interactions to all occur in one place and make it easy to manage them. ERP and CRM systems make it possible to track and improve these relationships over a period of time by allowing for seamless information flows across the customer lifecycle.
Frequently Asked Questions About the CLV Formula
Understanding CLV and the customer lifetime formula will allow your business to make better marketing and sales decisions. As a business owner, you will be able to use this metric and gain insight into your business and your customers as a whole.
To better understand the importance of customer lifetime value and the customer lifetime value formula, read the following commonly asked questions.
How Do You Calculate the Lifetime Value of a Customer?
To calculate the lifetime value of a customer, you need to use the following formula:
Lifetime Value = Customer Average Purchase Value x Average Purchase Frequency x Average Customer Lifespan
What Is Meant by Customer Lifetime Value?
The meaning of customer lifetime value refers to the money a business earns from the average customer over the span of their relationship with the company. The CLV helps businesses forecast profitability, determine growth and improvement goals, and set customer acquisition budgets.
What Is the Difference Between CLV and LTV?
The difference between customer lifetime value (CLV) and lifetime value (LTV) is that LTV refers to the average customer lifetime value over the entire customer base and CLV is the lifetime value of an individual customer. These are two important metrics for businesses to use.