Customer Lifetime Value
How much is a customer worth throughout their entire relationship with your company? The answer is their lifetime value (LTV), also known as customer lifetime value (CLTV). It’s a metric that goes beyond purchases to inform investment in both customer acquisition and retention.
The Value of Knowing a Customer’s Lifetime Value
Gaining and retaining as many customers as possible is usually what a company wants. But what if acquiring and retaining a customer costs more than what they spend? Or maybe you want to know what type of customer spends the most over time?
Lifetime value is about the profit potential of a customer, which tells you how much you should invest in keeping that customer or going after a particular market segment. Knowing LTV helps you make more informed business decisions that drive revenue and increase profitability.
Measuring and tracking LTV can be used to determine:
- How much your business can spend to acquire a particular type of customer and still remain profitable.
- How long it takes to recoup acquisition costs.
- How much to invest to retain customers.
- The customer cohort that is most profitable overall.
- The types of products and services that customers with the highest LTV purchase.
- The potential for increasing how much a customer spends over the course of your relationship.
- Primary drivers of customer lifetime value.
- The early signs of customer attrition.
- What encourages customers to spend.
- What encourages customers to remain loyal.
LTV is a key performance indicator (KPI) for many businesses because it is so pivotal for profitability. No acquisition and retention strategy is complete without first understanding the lifetime value of your customers.
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Factors that Affect Lifetime Value
Customer lifetime value is about much more than how much money a person spends. That’s a key piece of information, but several other factors influence LTV, including:
Cost of Customer Acquisition
How much did it cost to convert a lead into a paying customer? If the acquisition costs are greater than LTV profitability isn’t possible.
Keeping customers happy is usually good for business since existing customers are much more likely to purchase again compared to new customers. However, spending has to outpace retention costs, also known as cost to serve. One thing to keep in mind is how retention costs change over time. For many businesses, it costs less to retain a customer the longer the relationship lasts.
Frequency of Purchases
The more often a customer buys the higher their lifetime value will be no matter the price point of the item or service being purchased.
Introduction of New Competitors
This factor plays into retention. If a new competitor comes along it can throw off your LTV projections, especially if you are among the first to corner the market. If you notice a shift in market share it’s time to reexamine LTV metrics.
Calculating Lifetime Value
Lifetime value is a tangible measurement that is data-driven. As long as you have a data analytics platform that can provide information on how much customers purchase, calculating LTV is fairly straightforward.
The simplest equation for calculating gross customer lifetime value looks like this:
Average Purchase Price
Number of Purchases Each Year
Average Number of Years as a Customer (Customer Lifespan)
Average Purchase Price: This can be across the board, for a specific customer or a customer cohort. To get a generic average purchase price, divide your total revenue for a period of time by the number of purchases that are made during that time.
Number of Purchases/Purchase Frequency Rate: Again this can be for a specific customer, customer cohort or across all customers. For a general number, divide the total number of purchases for a period of time by the number of unique customers.
Customer Lifespan: You’ll need data over a period of time to calculate the average number of months/years customers continue to do business with your company. Don’t have enough data yet? You can get an estimate by dividing 1 by churn rate percentage.
Let’s assume you own an IT company that provides support for businesses. Below are two customer LTV scenarios:
Business A purchases a monthly unlimited service call package for $500 a month. On average businesses renew the package for four years. The LTV for Business A would be:
$500 X 12 X 4 = $24,000
Business B chooses to purchase one-off services as needed instead of the monthly unlimited service. The service calls cost $100 on average and 3 calls a month are made for the course of five years.
$300 x 12 x 5 = $18,000
In this example, businesses with monthly service call packages are more valuable to the IT company based on spending alone.
But that isn’t the end of the equation. Cost to acquire and retain the customer must also be factored in to calculate the net LTV:
Customer Lifetime Spend
Services Rendered to Retain a Customer
Calculating LTV can tell you more than how valuable a customer or group of customers is. It can also reveal the drivers behind customer lifetime value and ways to increase it. Measuring LTV can also help you decide which products to develop or which features to add in order to attract and retain customers without increasing costs.
Customer lifetime value is a KPI that’s worth tracking. With the right data analytics platform and communication between departments, calculating and projecting LTV is relatively simple. The information can be used by product development, marketing, sales and customer service teams to better serve customers, target the most valuable market and boost profitability.
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