What is the LTV of your customers?
‘Lifetime value’ is a phrase that many marketing people talk about, but not many truly understand it.
So let’s start from the basics: what is the lifetime value of your customer?
According to Wikipedia, “lifetime value (LTV) is a prediction of the net profit attributed to the entire future relationship with a customer.”
Let’s break this sentence down to make sure we get every single nuanced and subtle bit.
The fact that it’s a prediction means that LTV is only an estimate rather than a linear formula.
“…of the net profit…”
This is key.
When we talk about LTV, we don’t only consider “how much money this person is going to pay me in the future?”, but “what profit I am likely to gain from this relationship?”.
LTV takes into consideration every single penny of advertising and production cost you spend on the relationship you have with your customer(s).
“…the entire future relationship with your customer”
A lot of e-Commerce companies only consider the front-end sales you make with Facebook ads using the power of impulse purchasing.
Some of the more intermediate guys also add a bit of email marketing to follow up with those who abandoned their cart, and maybe even a short post-purchase sequence.
However, the most advanced businesses think long term and take on the mindset of focusing on lifetime value, rather than next days’, weeks’, months revenue.
They build relationships.
How to calculate LTV?
Here is the formula according to Hubspot.com:
[Avg. Purchase Value] x [Avg. Purchase Frequency Rate] x [Avg. Customer Lifespan]
Alright so now that we have the main formula, let’s break down how to get each number.
Average Purchase Value
Depending on the products you sell, take your total revenue during a given time period you think is statistically significant (usually taking one year is reliable enough).
You want to then divide this number by the total number of purchases made within that same period.
If you have cheaper items (let’s say below $100) then one year is absolutely fine.
If you sell stuff above $1,000, then maybe take a longer period if you can.
Average Purchase Frequency Rate
Divide the number of purchases over the course of the time period by the number of unique customers who made purchases during that time period.
[Average Purchase Value] x [Average Purchase Frequency Rate]
Average Customer Lifespan
The average of the number of years a customer keeps on purchasing from your company.
Add together the number of years through which each customer purchases from you divided by the number of observations, aka the average customer lifespan.
It’s not that simple after all, is it?
Not gonna lie here, you do need to be in business for a bit of time in order to seriously make this calculation, but even if you aren’t, it might be a good idea to start thinking about this and make some educated guesses/predictions.
Here is how Ezra, the absolute legend thinks about this thing:
This was Ben
P.S. What is your customers’ lifetime value? If you are not sure just take a guess. Either way, let us know in the comments below!