Businesses understand that the value of a new customer extends far beyond the first transaction – and this is especially the case in the travel industry. Undoubtedly the most valuable customer is a loyal customer. In most instances, the cost of acquiring a new customer will barely cover the overheads associated with the purchase. Therefore, ‘Customer Lifetime Value’ could not be more important. As a result, businesses should seek to cultivate a long, prosperous relationship with a new customer. Here, we demonstrate the value a returning customer can generate.
CLV metrics: How to quantify the value of a new customer
In fact, there is a simple formula to calculate exactly how much a loyal customer will spend over time. This formula is known as Customer Lifetime Value (CLV), which is based on 3 metrics. These are:1. Average Spend
2. Repeat Sales
3. Average Retention Time
The first step towards calculating CLV is understanding and estimating these metrics.
1. Average Spend
A customer’s ‘average spend’, or ‘average order’, is simply how much the customer spends each time they made a purchase. However, average spend can be misleading at times. This is due to the number of factors that influence the estimate.
Consequently, it is often more useful to segment your customer database. This strategy is particularly relevant in the travel industry, as the cost of products can vary significantly. For instance, there is a substantial difference in price between domestic and international flights.
This is illustrated by data from the US Department of Transportation – according to their study, the ‘average’ domestic flight cost approximately $378 in 2014, whereas an international trip cost closer to $1000. Clearly, different types of travellers need to be segmented to identify an average spend for each one.
2. Repeat Sales
Once you determine average spend, the next step is to calculate ‘repeat sales’. A repeat sale is the average number of times the customer makes a purchase per annum. For example, if a customer usually makes a purchase 3 times per year, their average repeat sale value is 3. If the customer only makes a purchase once every 2 years, their repeat sales value is 0.5.
As with average spend, customer segments need to be considered to generate a meaningful metric. As a case study, a hotel in New York may find that business travelers book over 10 times a year, whereas a leisure travel destination may only take a booking from the same customer once every 3 years.
3. Average Retention Time
The third metric is essentially the ‘lifetime’ in Customer Lifetime Value. ‘Retention time’ is the period of time a customer will continue to return to the company. If you are a long-standing business, this information can be extracted from historical data. A newer business, however, may need to make some projections which the company can extract from a data sample or via industry standards.
The mathematical proof: How loyalty = profit
The formula for calculating Customer Lifetime Value is as follows:
(Average Spend) x (Number of Repeat Sales) x (Average Retention Time)
= Customer Lifetime Value
To give a practical example, our hotel in New York hosts business customers who generally spend $200 each stay. On average, they book 3 times a year, and they continue to return for 5 years:
$200 x 3 x 5 = $3000 CLV
It is also prudent to include the Gross Margin as part of the calculation. Gross Margin is the measure of total revenue, minus the cost of the goods sold. Gross Margin is expressed as a percentage. So, to illustrate, if our New York hotel’s Gross margin is 5%, then the final CLV is:
$3000 x 5% = $150
Beyond the numbers: How to value customer experience
It is also important to measure the value a new customer extends beyond the revenue generated. Each customer will speak about their experience and may recommend the business. Subsequently, there is a potential referral in each customer. This is particularly the case nowadays, especially as social media influence plays such a significant role.
There is data to support this hypothesis. In general, dissatisfied customer will tell between 9–15 people about their experience. Furthermore, around 13% of dissatisfied customers tell more than 20 people. According to IATA research, an airline’s reputation is the defining factor when selecting a flight for approximately 7% of all passengers.
Why returning customers are key to revenue
Retaining customers is certainly more profitable than acquiring new customers. On average, it is 6–7 times more expensive to acquire a new customer than it is to keep a return customer. Therefore, having a robust understanding of your CLV helps you to justify dedicating resources to customer experience and retention.
Simply put, your CLV is the metric that tells you how much a customer is worth to you — and it is probably more than you think.