All of your customers are important to your business. But as the saying goes, “some customers are more equal than others.” Understanding the value of your customers across the lifetime of their relationship with your brand (not just the revenue from one transaction) can help you make more informed decisions around your marketing budget.
Today’s post takes a close look at customer LTV (or lifetime value), how to approach calculating it for your business and why it matters.
Customer Lifetime Value (LTV) Defined
LTV is the projected amount of revenue a customer will generate beyond a single transaction over the course of their entire relationship with your brand. In other words, LTV measures what each customer is potentially “worth.”
From a budget standpoint, customer LTV represents the maximum you should be spending to acquire a new customer. If the cost of acquiring a new customer is higher than your customer LTV, you will be losing money.
How you calculate customer LTV will depend on your industry, business model and target market. For instance, a business with lower-value products purchased on a more frequent basis (such as a coffee shop, for example), will approach calculating LTV differently than a business with higher-value products purchased less frequently (such as a furniture store, home improvement business or car dealership).
Why Should You Know (and Care About) Your Customer LTV?
No matter your business model, it costs more to acquire a new customer than to retain an existing one. That’s why it’s important to understand the value of your customers over their lifespan—so that you can more accurately determine how much to invest in acquiring new customers, as well as how much you should spend on keeping existing customers happy and building brand loyalty.
For example, have you ever said to yourself, “We can’t afford TV”? Knowing your customer LTV contributes data to your budget process that can help you to better estimate and justify marketing expenses. Perhaps you’ve thought, “We don’t need to reach many people,” and haven’t yet leveraged digital marketing tactics like search advertising or retargeting solutions. Understanding LTV can translate to planning and evaluating your marketing strategy with a focus on long-term relationships.
2 Potential LTV Formulas to Get Started
For a low-value, high-frequency business offering, you might use the following simple formula for calculating customer LTV:
LTV = 52(a) x t
- a = Average customer value per week (expenditures x visits)
- t = Average customer lifespan (time someone remains a customer, e.g. 5 years)
For a higher-value, lower-frequency business offering, the following traditional LTV formula may be more appropriate:
LTV = m ( r / (1 + i – r) )
- m = Average gross margin per customer lifespan
- r = Customer retention rate (% of customers who repurchase)
- i = Rate of discount (usually falls between 8% and 15%)
Bear in mind that your customer LTV formula may look a little different for specific segments. By segmenting your customer database and keeping tabs on LTV calculations, you can better allocate time and resources on your best customers. Investing in marketing to “good” customers—those likely to make repeat purchases, bring in referrals, be brand ambassadors on social media and so on—makes more sense than pursuing “cheap customers,” those who may be easy to reach but only come through the door once or twice. Also know that your customer LTV may change over time, and it’s just one of many variables that will influence your marketing decisions.
Calculating customer LTV allows you to evaluate your customer base in terms of the profitability of your different segments, enabling you to better determine how much to spend on acquisition and retention. You can then focus marketing efforts on your most valuable customers and more effectively allocate resources.
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