How to Calculate Customer Lifetime Value
In marketing, Lifetime Value is sometimes referred to as LTV, Customer Lifetime Value (CLV), or Lifetime Customer Value (LCV). Lifetime value is the value a customer gives to your business over the lifetime of your relationship with that customer. Or in other words, you take profit earned from a customer over a period of time and subtract the costs it took you to acquire that customer. LTV determines how much money you are willing to spend on acquiring that new customer and how much repeat business you can expect.
LTV truly addresses the core health of your business. It’s imperative your LTV is greater than your Customer Acquisition Cost (CAC). If your LTV is lower than your CAC, then you are losing money and you need to lower costs and re-evaluate your marketing efforts.
Calculating LTV by acquisition channel will allow you to determine whether you can spend more or less per channel. Try calculating LTV by customers acquired through email, Facebook, retargeting, CPC and see whether you are overspending or maybe underspending.
There are 2 methods at calculating LTV:
1. Historical LTV (good calculation)
Average revenue per customer per month (total revenue ÷ number of months since customer made their 1st purchase), add them all up, and then multiply by 12 or 24 to get a one- or two-year LTV.
This calculation basically sums up historical revenue per customer. The problem with historical LTV is that it is backward-looking and does not consider “time”; Your new and old customers will be categorized together even though their behavior might be very different.
2. Predictive LTV (great calculation)
This calculation predicts what new customers will spend in their lifetime as your customer – understanding a customer’s long-term value NOW.
Depending on your business needs, here are a few basic LTV calculations to choose from (factoring in profit and cost is a good approach if you are unsure):
(Annual profit per customer) x (Avg number of years they remain a customer) – Initial cost of customer acquisition = LTV
You can find profit by subtracting product costs and service costs from revenue. To find the customer lifetime in years, it is easier if you already have your Customer Retention Rate (see formula in section below). Most companies already have this, but do not know the customer lifetime in years. You can easily convert the retention rate into average number of years.
(Average Order Value) ÷ (1 – (Repeat Purchase Rate)) – Customer Acquisition Cost = LTV
(Average Order Value) X (Number of Repeat Transactions) X (Average Retention Time in Months or Years for a Typical Customer) = LTV
(Average Order Value) x (Purchase Frequency) x Margin = LTV
This calculation is a simpler method at factoring in profit from a customer.
Here are some important metrics & calculations you might need to determine your LTV:
Repeat Purchase Rate
Repeat Customers / Total Customers
(Multiply the decimal number by 100 to get your percentage)
Customer Retention Rate
Customer Retention Rate = ((CE – CN)/CS)) X 100
CE = number of customers at end of period
CN = number of new customers acquired during period
CS = number of customers at start of period
Number of Orders (365 days) ÷ Number of Unique Customers (365 days)
Average Order Value
Total Revenue (365 days) ÷ Total Number of Orders (365 days)
Time Between Purchases (this metric tells you how long before a customer makes a repeat purchase)
365 days ÷ Purchase Frequency
Average Customer Lifetime Period (once you have your retention rate, you can easily calculate the average customer lifetime in years)
1 ÷ Churn (loss) Rate%
If your retention rate is 80%, then naturally your Churn (loss) rate is 20% as the two rates always add up to 100%. In this example, the formula looks like this: 1 ÷ 20% = 5 years
Calculate LTV so you can identify your customer valuations
While the golden rule says to treat everyone the same, it doesn’t apply to your customers; meaning, you have some customers that spend more than others, and therefore, your marketing, loyalty programs, landing pages, content etc. should be tailored specifically to each of your customers.
Knowing your customer LTV gives you the ability to make strategic marketing decisions for certain customers by influencing their behavior to increase their overall lifetime value. Segment your customer valuations so you can send personalized messaging. Use LTV to help you decide where and how much to spend on customer acquisition or if you can give a discount to really push that new customer to convert.
Customer Lifetime Value turns the spotlight on long-term customer relationships rather than quarterly profits. In the long run, this is what counts.