Not all customers are created equal. Every business owner is well aware that a portion of customers are loyal and will repeat purchase in a predictable way and others will lapse, or no longer purchase from the business. A customers’ behavior related to how frequently they buy and how much they spend are factored into a critical metric, their LTV, or Lifetime Value to the business.
How to calculate customer Lifetime Value
Customer Lifetime Value (CLTV or LTV) is not a particularly difficult equation to master, it’s simply Gross Revenue – Costs = Gross Margin. This Gross Margin is then accumulated every time a customer returns to your store to repurchase. Let’s look at a Lifetime Value example: let’s say your average revenue is $50 for a customer’s first order. Taking out costs might leave you with $30 of Gross Margin. And in a given month you acquire 1,000 new customers so that your initial gross margin from those 1,000 customers is $30,000. Over the next 12 months, 25% of these new 1,000 customers return to your site and make another purchase, bringing in another $30 in gross margin per repurchase (1,000 * 25% repurchase rate * $30 = $7,500). Your 12-month LTV for this group of 1,000 customers is going to be the initial $30,000 in gross margin + the $7,500 in repurchase gross margin divided by the total number of customers ($30,000 + $7,500)/1,000 = $37.50.
What’s the right time period to measure?
It depends. There isn’t a wrong answer, and many factors will play into it, like frequency of purchase, seasonality, or how much change your industry might be projected to face in the coming years. For many businesses a 12-, 24-, or 36-month window is what is used to measure LTV. Businesses with very long purchase cycles, such as automobiles, would likely use a much longer time period. Ultimately, it’s a business decision that you can control.
The importance of Lifetime Value
Understanding how valuable your customers will be to your business over time can help you understand how much to spend to acquire them. If we stick with the example above, knowing there is $30 of Gross Margin in someone’s first order might mean you are willing to spend <$30 to acquire a new customer. However given the $37.50 LTV in our example, you should be willing to spend more than $30 as trends show they will become profitable to you over their lifetime as a customer.
But wait, it gets much more exciting than that!
Aside form looking at your entire customer file and determining LTV, you can do more sophisticated analysis by different cohorts and uncover where you should invest more or less.
LTV by Acquisition Date
A common way to look at LTV is by Quarter the customer was acquired. Check out the chart from Daasity’s analytics platform below. In this example you can see LTV increasing at a fairly steep rate for this company! Each Quarter (represented by a different colored line) starts out a bit higher, meaning there could have been site optimizations for increased upsells, pricing changes or perhaps a product line extension plan that has increased the value of the first purchase over time.
Tip: TOB = Time on Books = How long have these people been customers
What marketing channel customers were acquired from
This is a really important one and might have you thinking twice about how budgets are allocated. Just like customers don’t purchase in the same manner as each other, customers acquired through different marketing channels don’t perform the same and have extra costs that should be factored in. Segmenting customer LTV by marketing channel can be insightful because you may find a trend such as customers acquired by Channel A actually spend more money on their first purchase than customers acquired in Channel B. If we go back to our earlier example, maybe the average first purchase is $50, but Channel A customers might spend $60 and Channel B customers might only spend $35. Knowing that, you’d want to try to acquire more customers from Channel A, potentially by allocating marketing spend from Channel B to Channel A.
What product they first bought
Another way to use LTV is at the product level. Perhaps customers who buy a certain category of products have much higher LTV than average. You will want to both try to understand what characteristics make up that group of customers and also give that product more exposure in your store.
If you made it this far, then you know the Lifetime Value equation is
Revenue – Costs = Gross Margin
over the lifetime of your customer, usually a 12-, 24- or 36-month period. You also know three ways to look at it is:
1. By customer acquisition date
2. And by marketing channel acquired
3. By product
And you can better allocate budgets, spend more to acquire more valuable customers and avoid less valuable customers.
If you need help determining Lifetime Value for your customers, we can help. Contact Daasity today.