Customer Lifetime Value

Customer Lifetime Value (also known as CLV or LTV) is a crucial metric that estimates the total Net Profit a company can expect to earn from an average customer over the entire duration of their relationship. Think of it as the total treasure a company can expect to unearth from a single loyal customer, from their very first purchase to their very last. Instead of just looking at a single transaction, CLV provides a long-term perspective on a customer's worth. This forward-looking calculation forces a business to focus on building lasting relationships rather than chasing short-term sales. For investors, it’s a powerful lens through which to assess the health of a company's business model and the loyalty of its customer base. A high and rising CLV is often a hallmark of a company with a strong Competitive Advantage.

For a Value Investing practitioner, CLV is more than just marketing jargon; it's a direct indicator of business quality and durability. A company that consistently generates a high CLV from its customers likely possesses a deep Moat. Why? Because satisfied, loyal customers who stick around for years are the bedrock of predictable Revenue and robust Free Cash Flow. Here’s the secret sauce: a company with a high CLV can afford to spend more to attract new customers and still be wildly profitable. This creates a virtuous cycle where the company can out-market and out-grow its weaker competitors. When you’re analysing a business, understanding its CLV relative to its Customer Acquisition Cost (CAC) gives you a glimpse into its long-term profitability and resilience. A business that understands and actively works to increase its CLV is a business focused on creating genuine, lasting value—exactly what we look for as value investors.

Calculating a precise CLV can be complex, involving Discounted Cash Flow analysis to account for the time value of money. However, you don't need a PhD in mathematics to grasp the core components. Understanding these building blocks is enough to evaluate a company's strategy. A simplified CLV model is built on three key pillars:

• Average Order Value (AOV): How much does a customer spend on a typical purchase? (Total Revenue / Number of Orders)
• Purchase Frequency (F): How often does a customer buy from the company within a specific period (e.g., a year)? (Total Number of Orders / Total Number of Customers)
• Customer Lifespan (L): For how long does a customer keep buying from the company? This is often the trickiest part to estimate but can be inferred from customer churn rates.

By combining these, you can estimate the total revenue a customer will generate. To get to the value part, you must also factor in the company's profitability.

• Gross Margin (GM): What percentage of revenue is left after accounting for the cost of goods sold? A higher Gross Margin means each sale is more profitable.

Let's imagine a fictional company, “BeanBooster Coffee,” which sells premium coffee beans via a subscription service.

1. An average customer signs up for a subscription that costs €30 per month. So, their Annual Value is €30 x 12 months = €360.
2. On average, customers stay subscribed to BeanBooster for 4 years.
3. The company's Gross Margin on its coffee is 70%.

Let's do the math:

1. Lifetime Revenue per Customer: €360 (Annual Value) x 4 (Years) = €1,440
2. Lifetime Gross Profit (Our Simple CLV): €1,440 x 70% (Gross Margin) = €1,008

This €1,008 represents the total profit BeanBooster can expect from one customer before other operating costs. Now, let’s introduce its twin metric: Customer Acquisition Cost (CAC). If BeanBooster spends €250 on marketing to acquire that new subscriber, its net CLV is €1,008 - €250 = €758. The ratio of CLV to CAC (€1,008 / €250 ≈ 4) is what truly tells the story. A healthy CLV/CAC Ratio (typically 3:1 or higher) indicates a highly efficient and profitable business model.

As an investor, you can use the concept of CLV to sharpen your analysis and spot high-quality businesses.

• Read the Reports: Look for management that discusses CLV, LTV, or customer cohort analysis in their Annual Report or investor day presentations. This shows they are focused on long-term value creation.
• Analyze the Business Model: Businesses with built-in loyalty are CLV goldmines.
  • Subscription Model Businesses: Companies like Netflix, Adobe, or our fictional BeanBooster have highly predictable revenue streams and CLV, as customers pay on a recurring basis.
  • High Switching Costs Businesses: Think of your bank or enterprise software providers like Microsoft. The hassle and cost of switching keep customers locked in, leading to a long and profitable customer lifespan.
• Look for Clues of Customer Loyalty: Even without explicit CLV data, you can look for signs of a sticky customer base. High repeat purchase rates, glowing reviews, and a strong brand community all point towards a healthy CLV.