What is Customer Lifetime Value?

customer behavior

purchase history

brand interactions

This allows you to:

better understand your target market

develop strategies for acquiring new customers

identify opportunities for upselling or cross-selling products

maximize profits from existing customers

Now you know what it is, let’s discuss why it matters.

Why Customer Lifetime Value (CLV) Matters

Understanding how to measure customer loyalty is increasingly important in today’s competitive market. However, what’s the best way to monitor it? A key metric you’ll want to keep track of is the customer lifetime value (CLV).

Let’s delve deeper and explain why customer lifetime value is so important.

Customer Lifetime Value is the Best Analytics Metric

CLV sweeps away all other metrics because it focuses on long-term value, not the flash-in-the-pan appeal of visitor spikes and seasonal fluctuation. Customer lifetime value balances the profits in the e-commerce universe by flattening the peaks and troughs into a straight line of either success or failure.

CLV matters because it affects every area of your business. Take a look at how the customer’s lifecycle (lifetime value or LTV) impacts virtually every sector of an e-commerce business.

What do you see beyond the labels in the diagram above? I see marketing, strategy, outreach, UX, development, product, customer service, management decision-making, sales, PPCs — basically everything that makes an e-commerce business viable. LTV is part and parcel of it all.

Increasing LTV means higher profits.

LTV is also important because it shows you the path to higher profits. If you increase LTV, then you increase profits, plain and simple.

According to Marketing Metrics, the possibility of selling to a new prospect is 5-20%, but the probability of selling to an existing customer is 60-70%. By focusing on returning customers — their lifetime value — you are focusing on a strategy that gives your business higher profit margins.

BigCommerce, an e-commerce store provider, writes,

To ensure a high profit, it’s important to influence your customers to keep coming back to purchase. That means you want your churn to be low so that once you acquire a customer, they continue to come back and purchase again and again. Lower churn means higher LTV and a healthier business overall.

It isn’t enough just to know how much you spend to acquire a buyer.

You also need to know how much each customer is worth to your business.

Why? Because it gives you tremendous power.

Back in 2012, Amazon founder Jeff Bezos shocked the tech world by admitting that Amazon doesn’t make a profit on Kindles. Fast forward to 2022, and that’s still the case.

Why would the company spend millions developing a product that doesn’t make them money?

Because Amazon knows the total value of each customer and is willing to invest in products to increase that lifespan. In the case of the Kindle, the bet paid off.According to Bezos, people who buy Kindles read four times more books than they did before investing in Kindles.

Additionally, they don’t stop buying paper books. Kindle owners buy hardbacks, paperbacks, and audiobooks, too.

The Kindle is, at its heart, a marketing strategy — a strategy that Amazon could only deploy with a solid understanding of a customer’s lifetime value, or LTV.

But shockingly, LTV is out of the reach of most businesses, according to Invesp.Few understand this number. Let’s change that.

How To Calculate Lifetime Value: The Infographic

You already know about customer lifetime value, but hold up! How do you calculate it? In this graphic we’ll briefly cover how to calculate LTV and how to use LTV to help solidify your marketing budget. Special thanks to @avinash.

Click on the image below to view an enlarged version of this infographic.

If you sell a subscription product or software-as-a-service, it’s easy to calculate the average value of a customer.

Just take each billing cycle — one month, let’s say—and figure out how much the average customer spends.

If you don’t bill for a product on a regular basis, the math gets a little trickier. You’ll need to figure out two metrics: the frequency of the purchase cycle and the value of each purchase.

For example, an e-commerce site would calculate the size of each cart and how often customers order.

A company like Starbucks, with multiple purchases per week, calculates it like this, according to an analysis by Kissmetrics.But there may be other factors at play. Double-check these before making your number final.

Second, account for pricing variables.

Not all customers pay full price.

In fact, some industries make full price such a rarity that it’s an almost meaningless number.

J.C. Penney, for exa

mple, makes 99% of its revenue from items sold on sale, and three-fourths of this is marked down 50% or more.

Counting the LTV of a customer based on the ticket price is foolhardy if most purchases are discounted.

Instead, find the real price the customer pays. Exclude discounts, commissions, and processing fees (the percentage points that go to Stripe or Square or PayPal aren’t yours, so don’t count them).

Now that you know the actual value of one purchase cycle, let’s extrapolate that out to the customer’s lifetime.

Third, establish the lifetime of the customer. This isn’t literally how long your customer lives.

Instead, it’s the length of time a customer remains loyal to you. This number can be huge — the average customer lifespan of Starbucks is 20 years.

Of course, you won’t find a range like this if you’re just starting out (Starbucks couldn’t have known this ten years after opening its doors).

Instead, you can find the annual churn rate — or percentage of lost customers — each year.

Divide 100% by this churn rate. It’s a relatively simple calculation, but this reference chart can make it easier.As you’ll notice, improvements have a greater effect on lower churn rates.

While cutting churn rate in half from 90% to 45% only brings up customer lifespan by one year, reducing churn from 10% to 5% adds a full decade to the lifespan.

The lesson to be learned is not to be complacent once you have a low churn rate. That’s where you’ll find the biggest rewards.

Once you know the value and frequency of each buying cycle, just multiply it by the customer lifespan.

If your customer spends $20 per month and stays with your company for 2.5 years, he or she has a lifetime value of $600.

Using LTV and Customer Acquisition Cost (CAC)

Let’s talk about LTV and customer acquisition cost, but first, time for a quick definition. CAC measures the amount it costs to acquire a customer. That means everything you spend on marketing, sales, and the usual costs of running a business (equipment and premises).

If you spend less to acquire a customer than that customer is worth, all is well! If you can get a new customer for $100, and she spends $150 with you, keep at it.

Of course, the opposite is true. Remember, no matter how small the difference, a lower CAC than the LTV is always problematic.