Lifetime value is a deciding factor on how efficient your new customer acquisition needs to be and whether or not you can unleash the flood gates on your offers, paid media or affiliates.
What is Customer Lifetime Value (LTV)?
Customer Lifetime Value (LTV), also known as CLTV, is a metric that measures the total contribution a customer makes to your business over the duration of their relationship with you. It represents the financial value a customer brings, factoring in repeat purchases, order frequency, and other transactional elements.
For ecommerce businesses, LTV is a critical metric to understand customer profitability and optimize marketing strategies. By understanding LTV, you can make more informed decisions on customer acquisition costs, pricing strategies, and product offerings.
How to Calculate Customer Lifetime Value? Formula included
Customer Lifetime Value (LTV) is broadly calculated as the total contribution a customer makes to your business over the duration of their relationship with your brand. In simpler terms, it’s the sum of the profits generated from a customer’s purchases, minus the costs of acquiring and serving them.
Now, what should be included in contribution?
Contribution represents the actual marginal value collected after other expenses have been accounted for.
For example, if a product sells for $60 with cogs and other expenses of $30, then the contribution remaining is $30.
LTV represents the SUM of the contributions made by a customer over the lifetime of that customer.
Cohorts & LTV Work Together
Every customer is not created equal (some just joined yesterday, others have been around for years) we need a way to standardize our analysis and compare “apples” to “apples”.
To do this, we can create cohort specific groups for measuring LTV.
That’s just a fancy way of saying that we’ll group everyone by the day they purchased which will allow us to measure the relative time passed for each group of customers.
Visually this manifests as a table where the first column represents the date of the customer cohort, and the columns represent the relative contribution after 7,14,30,60,90,etc days.
Step-by-Step Process for Calculating LTV Using Cohorts
- Group Customers by Cohorts: Start by creating cohorts based on the date they made their first purchase. For instance, all customers who made their first purchase in January form one cohort, while those who started in February form another.
- Track Purchase Frequency: Measure how often customers in each cohort are making purchases over time. Some may buy once a month, while others might buy more sporadically.
- Calculate Average Order Value (AOV): For each cohort, calculate the average amount spent per order. This helps you estimate the revenue generated per customer for each purchase.
- Consider Costs: Deduct associated costs from the revenue to calculate the profit (or contribution) per customer.
- Aggregate and Analyze Over Time: Over 30, 60, 90, and 365 days, track how the LTV of each cohort grows.
- Project Future Value: Once you have enough data, you can forecast the potential LTV for new customers based on past cohort performance. This helps you adjust your marketing efforts and understand how much you can afford to spend on acquiring new customers.
Lifetime Value (LTV)Calculator
To make calculating your Customer Lifetime Value (LTV) easier, we’ve built a free online Lifetime Value (LTV) calculator that allows you to quickly estimate the lifetime value of your customers based on your specific data inputs.
For those seeking a more comprehensive solution of ecommerce metrics, VisionLabs offers custom dashboards that reveal your profit drivers, backed by expert strategists who turn data into action – all without the hassle of building an in-house team. If you want to know more, check our ecommerce data services.
LTV Examples
Let’s walk through a few examples to make the LTV concept more tangible.
Example 1: Basic Scenario
Let’s say your company spends $75 to acquire a new customer (Customer Acquisition Cost or CAC). The customer’s first purchase is worth $60, and it costs $20 to fulfill (cost of goods sold, shipping, etc.). So, your profit from this first order, or contribution, is: $60-$20=$40 contribution.
However, when you factor in the $75 CAC, this initial transaction results in a net loss: $40-$75 =-$35.
Now, this is where Customer Lifetime Value (LTV) becomes crucial. If the customer makes a second purchase after three months, again spending $60 with the same $20 cost, you earn another $40 in contribution. So now, your total contribution from this customer is: $40+$40=$80 total contribution.
When you subtract the $75 CAC from the total contribution, you see that $80-$75 = $5 profit.
This example shows that while the first purchase wasn’t profitable, the customer became profitable after their second purchase, highlighting the importance of repeat purchases in calculating LTV.
Example 2: Using Cohorts
Let’s apply this concept to a cohort of 1,000 customers acquired in January. You spent $75,000 to acquire these customers.
- In January, these 1,000 purchases had an average order value (AOV) of $60, and the cost per order was $20. The total contribution from January is: 1,000 x ($60 – $20) = $40,000.
However, since you spent $75,000 to acquire these customers, there is still a net loss of $40,000-$75,000= -$35,000.
- Now, in February, 20% of this cohort makes another purchase, meaning 200 customers return to buy. They again spend an average of $60 with the same $20 cost, generating an additional contribution of 200 x ($60 – $20) = $8,000.
Adding this to January’s contribution gives $40,000 + $8,000 = $48,000 total contribution.
Subtracting the original CAC: $48,000 – $75,000 = -$27,000. Although you’re still at a loss, you’re getting closer to breaking even.
- If another 100 customers from the cohort make a purchase in March, the additional contribution would be 100 x ($60 – $20) = $4,000.
Now, your total contribution is $48,000 + $4,000 = $52,000
and subtracting the CAC: $52,000 – $75,000 = -$23,000
As customers continue to make repeat purchases over time, the contribution continues to grow, and eventually, the LTV of this cohort will surpass the initial $75,000 CAC, making the cohort profitable.
How to Improve Customer Lifetime Value
Improving LTV can have a significant impact on your ecommerce business. Here are some strategies to increase LTV:
- Optimize Product Offerings: Your product mix can play a crucial role in driving repeat purchases. Consumable goods, for example, can naturally lead to a higher LTV than one-time purchases.
- Enhance Customer Experience: Providing excellent customer service can encourage repeat purchases and build long-term loyalty.
- Upsell and Cross-Sell: Introduce customers to complementary products or premium options that enhance their experience.
- Loyalty Programs: Offering discounts, rewards, or special promotions for repeat buyers can boost customer retention.
Benchmarks: What’s a Good Customer Lifetime Value in Ecommerce?
A good LTV can vary by industry, but common benchmarks for ecommerce businesses often aim for a 30% increase in LTV within the first 90 days and a 100% increase by the end of 365 days. This means that your customers should double their initial value to the business over a year.
For instance, if a customer’s first purchase is $60, by the 90-day mark, their LTV should ideally be at least $78, and by day 365, it should reach $120.
Why is Customer Lifetime Value Important to Marketers?
LTV is essential for marketers because it directly influences decisions about customer acquisition and retention strategies. Understanding the LTV of your customers helps you determine:
- How much you can afford to spend on customer acquisition (through paid media, influencer marketing, or other channels).
- The effectiveness of your marketing campaigns in generating profitable customers over time.
- Customer segmentation strategies, allowing you to focus on your most valuable customers.
By knowing the lifetime value of your customers, you can allocate your marketing budget more effectively, ensuring you’re not overspending on customers who won’t bring enough value to your business in the long run.
Customer Lifetime Value vs. Customer Acquisition Cost (CAC)
LTV and CAC are closely related metrics. While LTV measures the total value a customer brings over time, Customer Acquisition Cost (CAC) refers to the amount spent to acquire that customer. The relationship between LTV and CAC is crucial for profitability. Ideally, your LTV should exceed CAC by at least 3 to 1 to maintain healthy margins.
For example, if your CAC is $75 and your LTV is only $60, you’re operating at a loss. In contrast, if your LTV is $180 and your CAC is $60, you’re more likely to have a profitable business.
FAQs
How often should I measure LTV?
It's best to track LTV periodically, such as monthly or quarterly, to see how changes in customer behavior or your marketing strategies impact the overall value.
What’s a good LTV/CAC ratio?
The ideal LTV/CAC ratio is 3:1. This means your LTV should be three times higher than your CAC to ensure sustainable growth.
Can LTV change over time?
Yes, LTV can fluctuate based on customer retention rates, purchase frequency, and changes in your product or marketing strategies.
Understanding Customer Lifetime Value is key to making smarter, more profitable marketing decisions in ecommerce. By regularly calculating and optimizing your LTV, you can improve your overall business performance and ensure long-term success.