What Is a Customer's Lifetime Value, and How Should You Use It?
Posted on October 10, 2019 by Dave Fowler
This article was originally posted on Chartio Blog
There are a lot of statistics that go into calculating the value of a customer for your business. One of the most important, however, is the customer's lifetime value. By understanding the average customer's lifetime value, you can get a better idea of how to structure your advertisements, how to reconnect with customers, and even whether you are doing an effective job of marketing to the customers your business already has.
What is a Customer's Lifetime Value?
A customer's lifetime value, or LTV, is the measurement of how much the customer is worth to your business over their entire tenure with the business. LTV measures not only what the customer will spend in a single transaction, but rather what they will continue to spend with your business over their lifetime with you. A customer that spends $300 in a single transaction with you, for example, might seem on the surface to hold more value than the customer who spends $100 in a single transaction. If, however, that $100 customer comes back to your business ten times to make future purchases, while the customer who spent $300 never returns, the $100 customer has more lifetime value for your business.
How to Calculate a Customer's Lifetime Value
In order to calculate the lifetime value of a customer, you need to know three key things:
- How much a customer spends in an average purchase with your business
- How often the customer makes those purchases
- The average length of time a customer will remain with your business
Divide the average length of time a customer stays with your business by the frequency of their purchasing habits. Then, multiply that number by the amount the customer spends in an average purchase. You can also use this formula to calculate the lifetime value of a specific customer or a specific buyer persona. For example:
Customer A spends $125 in an average purchase. Generally, Customer A makes a new purchase every six months, and will have an average lifespan of 3 years with your company. Customer A's lifetime value to your company, then, is $750.
Customer B, on the other hand, spends an average of $75 every 3 months, and will have an average lifespan of 10 years with your company. By contrast, Customer B's lifetime value to your company is $3,000.
In order to calculate the average lifetime value of your customers, you will need to know the average of the data points above: the average amount spent by your customers, the average frequency of purchasing behavior, and the average lifespan of your customers. You might, for example, discover that the average customer spends $100 each time they make a purchase with your store. On average, customers visit your store 5 times a year, and they tend to stay with your business for around 5 years before moving on. In this case, the average value of a customer over their lifetime is $2,500.
The formula looks something like this:
Average spent by customers per purchase x average frequency of purchases per year x years the customer spends with your company = customer's lifetime value
Effectively Using Lifetime Value to Drive Your Business Decisions
When you know your customers' lifetime value, you know the average worth of a customer to your business. That tells you several key things:
How Much Can You Afford to Spend on Advertising?
If you discover that the average customer's lifetime value to your company is only $250, you don't want to spend $100 per click on advertisements that have only a 25% chance of converting: you will very quickly start spending more on your marketing efforts than you can bring in with new customers. On the other hand, if you discover that a customer's lifetime value is $2,000 for your company, you might be incredibly willing to go out on a limb and spend $250 or more to bring in that new customer.
What Buyer Persona Represents Your Best Customers
When you calculate the lifetime value of your customers, you shouldn't just look at your customer base as a whole. Instead, take a look at segments of your customer base. Is one segment or buyer persona routinely spending more (or staying with your business longer) than another segment? If so, you may want to focus on marketing to that specific segment; or, you might want to shift your efforts so that you can offer products more likely to appeal to buyers who are currently spending less at your store, encouraging them to make bigger purchases in the future.
What Is Your Customer Service Worth?
When it comes to spending money on your customers, it doesn't stop when you bring them in the door. You also need to keep your customers. That may include retargeting campaigns, emails, and even your customer service. When you get a look at your customer lifetime value, you will have a better idea of what you can afford to spend to keep your customers happy. Imagine a restaurant, for example. If you have a customer who comes in twice a month, routinely spending $50-$75, you can afford to spend a little more--comping a meal when things go wrong, for example--to keep that customer coming in. Failing to provide that expert customer service, on the other hand, could lose you a long-term customer--and when that customer finds a new restaurant, they may not want to come back to yours.
How Long Are Customers Likely to Stick With Your Business?
What do you need to do to retain customers longer? Is customer retention a challenge for your business, or do you often bring customers back? As you examine your customer lifetime value, you will likely find one of three things:
- Your customers tend to be very loyal. They are happy with the services you provide for them, so they come back to your business for future industry needs.
- Your customers are hit or miss. Some of them buy from you most of the time, but they're equally open to using your competitors if they have a better deal.
- You tend to only have customers who come in once or twice. Typically, they will make a big one-time purchase from you, then move on.
As you start to examine that customer lifetime, you may discover that you need to make alterations to your business plan to keep customers happier: providing better customer service, spending more effort to retarget customers who have purchased from your business in the past, or making sure that you provide exactly the products and services your customers are looking for at a price they can afford to pay, for example. Evaluate:
What Is Your Customer Retention Rate?
Calculate how many customers:
- You have at the start of a period (A)
- End of a period (B)
- New customers you have (C)
B-C will give you the number of customers remaining at the end of a period (D). D divided by A times 100 will allow you to see the percentage of customers you are able to retain.
What Customer Lifetime Value Won't Tell You
Customer lifetime value can tell you a great deal about the buying habits of your customers and how much they're worth. It's important, however, that you don't misuse that data. Consider:
Don't allow perceived lifetime value to cause you to devalue customers you view as being worth "less". Some businesses, for example, may group their customers by race or gender, only to discover that they've made a mistake somewhere in that equation--and as a result, you may lose a larger segment of your customer base than you think.
Make sure that you continue to offer value to all of your customers. You never know when a customer that you perceive as being part of a segment that has less value for your business will have a connection to someone who has greater value.
Don't include the money already spent to acquire a customer in your calculations. Customer acquisition cost is important, but you shouldn't use past costs to influence how you choose to proceed moving forward.
Proxy Metrics for Customer Lifetime Value
Are you struggling to get the numbers you need to measure the lifetime value of a customer with your company? Consider:
Take a Look at the Average Purchase Costs
Average purchase costs won't give you the big-picture look at what your customers are worth to your company over a lifetime, but they can help you better understand what customers are spending--and, in many cases, how to boost that spending.
Examine the Customer Churn Rate
If you don't know how long your customers usually stay with your business, consider how long it takes them to leave it. If you notice that customers are likely to jump ship quickly, it may give you a better idea of where your business needs to make some changes. On the other hand, if you notice that your customers tend to be very loyal, take it as a sign that you're doing something right and evaluate the steps you're taking so that you can continue to provide that high value for your customers.
The Bottom Line
Measuring customer lifetime value is a highly effective way to guide your future marketing decisions. You may also find, as you examine customer lifetime value, that you need to take steps to more effectively keep the customers you've already captured, rather than allowing them to slip through your fingers. With the Chartio system, you will have the ability to calculate a number of key metrics that have value to your business and observe how they change over time, which can ultimately help you increase the lifetime value of each customer to your business.