Customer Lifetime Value: How you calculate LTV

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For developing business success, it is not only important for a company to create a large customer list.

Rather, you should try to bring the relationship of customer acquisition costs (CAC) to customer lifetime value (CLV or LTV) to the right level. That means controlling two of the most important unit economics. 

 

Customer Lifetime Value - that's what it is about

 If the key figures are used, then you can lower the acquisition costs in your marketing measures and, secondly, increase the value of the current and (potentially future) customer. The second area usually involves the development and management of the customer relationship. By calculating the customer lifetime value and estimating its change over the years, a company can transform its less desirable customers into valuable assets.
 
Recently the Forbes Magazine wrote about why you should balance your Cost of Acquisition against the Customer Lifetime Value.

What is Customer Lifetime Value?

The term CLV describes the average expected profit that a company has over the entire business relationship of each customer. Inflation and retention rates are taken into account to predict how a customer changes from year to year.
 
A simple model shows the impact of marketing costs and discounts on the CLV. More complex models can be created to accommodate different types of customers, variations in retention rate, and different products.
 
The importance of the CLV is to determine the true value of a customer. It shows the value that a buyer generates entirely for the company. When customers use your website, you can use the Customer Lifetime Value to estimate what the customer will gain over the long term. With the help of the CLV, marketing costs and budget questions can be better calculated and later optimized.

A Process to Calculate Customer Lifetime Value in 2 Steps

From the outside, the calculation of the customer’s life value usually looks quite complex. Do not worry, with this guide you will come in 2 concrete and comprehensible steps to the result. 

 

Step 1: Calculate the average of variable values

These are:

  • = the expenses of your customers per visit / purchase
  • = the number of visits / purchases per week, the buying cycle
  • = the average customer value per week, expenditures x number of visits
 

Intermediate step: Collect the (constant) values necessary for the calculation

The Customer Lifetime Value corresponds to the gross profit generated per customer, ie the difference between the turnover with your customers and the variable costs. Therefore, you should gather these values:

  • t = the average customer lifetime.. In our example: 20 years
  • m = the the gross profit generated with the customer. In our example: $ 5382.94
  • r = the re-purchase rate. In our example: 75%
  • i = the discount factor for the current value of future cash flows. In our example: 10%
  • p = the profit margin per customer. In our example 21,3%
 

The average customer lifetime is statistically charged over existing customers. 

The average gross profit (not to be confused with the contribution margin) represents the difference between the sales revenues and the use of goods.

The repurchase rate is the percentage of customers who buy again in percentage terms from an initial customer group. This parameter is subject to a great deal of uncertainty.

The discount factor is used to determine a current value for cash flows that lie in the future:

In addition to this, various other influencing factors for the customer lifetime value can (or must) be taken into account:

  • Temporary contracts, so a limited duration
  • Discounts that you give customers
  • Costs for customer loyalty and customer care
  • seasonality 
 

In addition, the Customer Lifetime Value can also be calculated for periods other than one year and used as a forecast.

 

Step 2: Calculate Customer Lifetime Value

To calculate the customer’s life value, several paths lead to the destination. In our example, find the most commonly used calculation methods for the CLV. Use the following formula singly or in combination.

The simple CLV formula: 52 (a) * t
The custom CLV formula: t (52 * s * c * p)
The classic CLV formula: m * r / (1 + ir)

 
Customer Lifetime Value Starbucks Case

LTV very often comes to Pareto

Customer Lifetime Value is a clear look at the advantage of getting and keeping any given customer. Not all clients are made equal. Actually, the top 1% of e-commerce clients are worth more than 18 times up to average clients.

As a business owner, you should have the capacity to concentrate your efforts on getting the potential clients—the clients who will take your business from being a flash-in-the-pan accomplishment to a household name.

While CLV is extraordinarily valuable, it’s traditionally quite hard to calculate. In case, if you’ve endeavored to uncover your CVL in the past, you have most likely gotten yourself knee-deep in a complex algorithm as well as formulas. 

Fortunately, there are a lot easier approaches to figure out your CLV. Client behaviors are exceptionally hard to predict and can seem to be quite random at a glance which makes CLV an essentially unpredictable measure to track. Simply think about it. A few of your clients may make small buys each week and others may make big buys per year and their wide ranges of combinations in between. 

By measuring your CLV, you can easily know about how frequently specific types of clients will make buys and when those same customers will quit making buys for good.

Although there are various advances strategies for calculating Customer Lifetime Value out there, the approach that we have described above is a simple and easy way for you to get the information you need to refine your approach to client obtaining. 

Customer Lifetime Value estimation and understanding example

To show an easy example from activating a user to his churn, you may start with a free trial. As soon as the customer makes the first purchase of one of your products or services, the customer lifetime starts officially. 
 
It lasts via several renewals and it ends at the moment the customer churns from your solution. This is the very basic illustration of the LTV and should help you for a very first estimation.
Customer Lifetime Value simple example

Why is Customer Lifetime Value an important unit economic?

We all are familiar with the fact that it is more expensive to obtain new scenarios than to preserve existing ones – thus widening your CLV is important to a strong business model and retention strategy of customers.  

Have a look at a some of the reasons why utilizing CLV as a central metric is important if you want to boost productivity, preservation, and success of your ecommerce business.

1. Generate real ROI on customer acquisition

Customer Lifetime Value helps you concentrate on the channels that give you the best and the most advantageous clientele. You should be optimizing your marketing channels with respect to the lifetime value a customer puts into your brand, instead of the gross profit on the first purchase.

If you are concentrating on CLV, it will change the finances of your customer acquisition strategy. Out of the blue, you can pay a large number to obtain a customer as you are not hampered by the earnings produced from a particular purchase, but from the purchase made over time with your product.

2. Perk up your Action triggers

By sorting out data into natural clusters, you can find out the action triggers that boosts your best consumers to make their initial purchase. When you take a observe your stunning results, you must be trying to reproduce this action with your potential consumers in order to convert them into first-time purchasers.

By using the above-mentioned strategies to calculate Customer ltv, you’ll effortlessly have the capacity to take a preview of your customers’ acquiring history and flip it into a widescreen estimate of their future activities.

 

Get started with understanding your customer lifetime value

A lot of businesses act blindfolded when it comes to knowing about the value of their customers. 
 
Be different and get the insights of how much are you able to invest in customer acquisition always in the correct relation to customer lifetime value.

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As a founder and entrepreneur, I experience every day how important customer centricity is for companies.

Integrate the essential customer perspective into your product genesis and marketing processes. That puts horse powers on the street, until it runs.

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