What Is Lifetime Value?

The traditional business model looks at profits in terms of individual transactions. A customer visits your store or website, looks around, and makes a single purchase. If they return, their new purchase is counted as a separate transaction or conversion.

The problem with this model is that it doesn’t account for a customer’s overall experience with your brand. In a world where marketers pay for ad impressions and cultivate social media identities, a holistic view of the customer journey is more likely to provide insightful and actionable information.

Lifetime value is a metric that represents the amount a customer will spend over the duration of their relationship with your brand. Calculating lifetime value can help you understand who your most valuable customers are, how they interact with your company, and whether tapping into a new audience will actually be worth the cost of acquisition.

LTV and CLT

The terms lifetime value and customer lifetime value are often used interchangeably, but they actually have different meanings. Lifetime value, or LTV, represents the average money that a customer spends with your business. Customer lifetime value, or CLT, represents the amount of profit that your business makes from each individual customer.

This subtle difference is directly related to your profit margin. There’s no such thing as a business that’s completely free to run. From wages to materials to the rent for your office, your company’s expenses add up to create the overhead costs for your product or service. To calculate profits, you need to subtract overhead costs from the monetary value of each sale.

As a marketer, you’ll want to understand and reference both of these values. LTV represents the customer’s point of view, and CLT represents the company’s perspective. If your average customer has a high LTV but brings in a low CLT, then you might need to re-think your marketing budget.

The Ethics of CLT Campaigns

Before you start thinking of ways to increase your customer lifetime value, it’s essential to understand how your new campaign will impact your customer relationships. Heavy-handed campaigns and high-pressure sales tactics might work in the short term, but they will eventually drive away a large portion of your target audience.

The modern customer is surprisingly educated and aware of their own product needs and purchasing habits. Although many customers are open to upselling, very few are willing to spend more than the budget they’ve set aside for a specific part of their lifestyle.

As a marketer, always remember that the best way to increase customer lifetime value is to increase the value of your services. If a customer stands to gain from working with your business, they will continue to do so. If you try to upsell products that the customer does not want or need, they will eventually grow tired of the pressure and look for an alternative.

Old methods of direct marketing, like handwritten notes, are gaining momentum because people like the feeling of being someone special. When a handwritten note, complete with a handwritten envelope and Forever stamp is delivered it gets opened.

Cost of Acquisition

The cost of acquisition is the amount of your marketing budget that you will spend gaining an individual customer. This amount is typically calculated by dividing your monthly or seasonal marketing budget by the number of new leads that you brought in during that time period.

Another way to calculate the cost of acquisition is by tracking the customer journey. The cost of leads generated through social media shouldn’t necessarily include the money you spend on YouTube ads. This is why you need to know how to read analytics and understand where your traffic is coming from.

When you compare the cost of acquisition to a single transaction, the difference can seem staggering. But when you understand that a new lead will continue to generate profit for your company for several years, the price of modern marketing suddenly makes a lot more sense.

Customer Retention

Acquiring new customers is expensive. That’s why most companies prefer to focus on regular customers. Someone who has bought your product and loved it is likely to buy again – especially if you make an effort to retain and nurture that customer relationship.

Customer retention is the art of maintaining your customer base and is the best way to increase your average LTV. Some simple ways to retain your customers include maintaining the quality of your products or services, staying in touch with email newsletters or direct mail such as handwritten notes, offering loyalty programs, and encouraging your audience to follow you on social media.

How to Calculate Lifetime Value

As with all metrics, LTV is meant to inform and guide your marketing decisions. Develop a consistent formula that you and your team can easily understand. Remember that although metrics can reflect reality, they shouldn’t be relied upon for real predictions.

Audience Segmentation

Before you get started, think about whether it makes sense to place all of your customers in the same category. If you’re a small or medium-sized business, there’s a good chance that your clients have similar purchasing habits. However, if you have one or two extremely high-value customers, incorporating them into your statistics will warp your average and give you a meaningless value.

The best way to decide if you need to segment your audience is to check for outliers. Most outliers are immediately visible; if your average customer spends $20, but one customer spent $600, you probably shouldn’t lump them in with the rest.

The main benefit of using audience segments is that you can plan for different audience behaviors and purchasing habits. Some customers spend $5 at a time but make multiple purchases in a single month. Other customers spend $500 at once but only visit your store once a year. Create unique categories for each of these customer profiles to get the most accurate calculations.

If your business is still small, you might not need to create audience segments. Instead, it might be more beneficial to remove the outliers and perform a single calculation. Make this decision based on the amount of available data and the goals of your LTV campaign.

Purchase Cycles

A purchase cycle represents a trackable period of customer interaction. Weekly, monthly, and yearly tracking cycles all work well for different business models.

When you’re just getting started, try using a yearly purchase cycle. This will make sure you’re not missing any customers who buy from your store on an inconsistent basis. You can switch to a monthly or weekly purchase cycle if you have a high volume of customers who consume your product as a regular part of their lifestyle.

One of the central values you’ll need for your LTV equation is the average number of transactions per cycle. Take all of the transactions in a single cycle, and divide this value by the number of unique customers. Don’t forget to find different values for each audience segment.

Retention Period

A retention period is the average amount of time that a customer will continue to do business for your company. As people’s lifestyles change, so do their purchasing habits. Even your favorite regular will eventually move on and look for different ways to spend their money.

Retention periods can be found by comparing the data from your returning customers. Large companies often plan for retention periods as great as 20 years. For most small or medium businesses, 3-year retention is more likely.

If you don’t know how to calculate your retention period, start with a 3-year or 5-year model. This represents the average length of college educations, career changes, and other lifestyle movements that might help predict your customer’s purchasing habits. As your business grows, keep tabs on the data to see how long customers actually stay with your company.

Average Customer Expenditure

Average customer expenditure represents how much a customer typically spends on each purchase. This metric is integral for calculating your LTV, so make sure your data is accurate.

To find average expenditure, add up all of the transaction values within a purchase cycle. Then, divide by the number of individual transactions. Don’t worry about how many unique customers there were; this data will be accounted for later on.

This is another point where it might be valuable to exclude your outliers or rely on audience segments. If you’re working with a large amount of data, you also might prefer to take the average of a small set of sample transactions. Remember to choose these transactions randomly to get the most accurate representation.

Profit Margin

Your profit margin is the amount of actual profit you can expect from each transaction. Profits are determined by subtracting the cost of materials, labor, overhead, and anything else that goes into creating your product or service.

Profit margins are necessary for CLT equations because they give you a clear picture of each customer’s value. A customer who spends $500 might only bring you $100 of actual profit. Knowing the difference will keep you from overspending your marketing budget.

As variables, profit margins are represented by percentages. If you make a 20% profit on every product, use 0.2 as your profit margin.

Calculating Value Per Cycle

The average customer value per purchase cycle is the primary variable used to determine LTV. This metric is calculated using a straightforward formula:

Average Value * Number of Transactions

Remember to find a new value per cycle for each of your audience segments. For some groups, it makes more sense to use a different purchase cycle length. If this is the case, remember to make a note of the difference in value, so you don’t confuse your equations.

Calculating Lifetime Value

Your lifetime value, or LTV, is the total amount that a customer will spend over the average retention period. To find this metric, use the following equation:

Value per Cycle * Number of Cycles per Period

Just like that, you know how much each customer is likely to spend with your business. This number isn’t wholly predictive, but it’s a good starting point for most marketing campaigns.

Calculating Customer Lifetime Value

Your customer lifetime value, or CLV, represents the actual profit that a customer brings to your company. This metric also uses a simple equation:

Lifetime Value * Profit Margin

LTV represents the customer’s perspective. If they spend $500 with your company, they probably won’t think about the fact that you only made a $100 profit. CLT represents your company’s perspective and is the most useful value for determining your marketing budget.

Adjusting the LTV Equation

Some companies use complicated equations to determine the lifetime value of their customers. Based on internal metrics, marketers might decide to add variables that represent the rate at which customers leave the company or the amount that customer income changes in reference to inflation.

These variables are more useful for companies that interact with extremely high customer volumes. When you have millions of transactions every year, altering a variable by even a single unit can alter your equation by a wide margin.

If you’re running a small or medium business, a simple LTV equation may actually be better for your overall strategy. LTV metrics are used to make underlying assumptions and budget plans, but they can’t actually be used to predict your profits for the next quarter. When you work with a simple equation, you know precisely what your metric represents and can use it to make intelligent and meaningful decisions.

Customer Relationship Management Software

Customer relationship management software, or CRMs, are the programs that companies use to track individual customer interactions. These programs collect information across multiple communication channels and turn it into accessible and readable reports.

CRMs are useful because they usually provide accurate LTV data for each of your customers. A great CRM can display the amount a customer has spent, calculate the cost of acquisition, and even identify which customers are ideal candidates for an upcoming remarketing campaign.

Choosing a CRM

Before you select a CRM, make sure that it can aggregate data from all of your consistent customer channels. Depending on your business model, your customers will probably get in touch through the following methods:

• Email: Your CRM should let you read and respond to emails from within the software. Attaching an email address to a customer account can also help you identify them on social media.
• Web forms: Contact forms and support queries are both crucial points of contact. Respond quickly to maintain the customer relationship.
• Chat: Online chat should be accessible from within the CRM, and you should be able to review old chats to gain customer insights. If you can’t be online 24/7, add a chatbot to answer questions after business hours.
• Social media: From posts to messages to company reviews, more and more customers are using social media as their primary form of company interaction. Advanced CRMs treat social media posts like support tickets and use algorithms to identify the most important posts.

Some of the most popular CRMs include Zendesk, Freshdesk, Zoho Desk, and Salesforce Essentials. If you work for a large company, you might already have a CRM solution; check to see if it has an analytics dashboard that you can use.

Using a CRM

Unless you own a small business, you probably won’t use your CRM to track individual customer interactions. As the marketer, your job will be to review data reports and make decisions based on the aggregated information.

Every CRM has a different dashboard, so you might need to click around to find the information you’re looking for. You can get started by sorting your customers into audience segments based on how much they spend, how long they’ve been with your company, or even which services they typically use.

Next, see if your CRM has an algorithm to identify customers who are ready for another point of contact. If it doesn’t, you can sort customers on your own by how long it’s been since they last purchased with your company.

And finally, don’t forget to check the CRM’s analytic data for your various marketing channels. You might be surprised to find out where your traffic is coming from and how many paying customers actually viewed your latest ad campaign.

Gaining New Customers

Every regular client started out as a new customer. As a marketer, you’re already a pro at getting your message in front of your target audience. Make sure you understand how those early impressions lead your customer down the marketing funnel and into a great business relationship.

First Contact

When it comes to developing a brand identity, first impressions really do matter. Your first contact with a customer can be defined as the first time they really see and interact with your brand. It could be a sidebar ad, a sponsorship on a YouTube video, or even a product display in their favorite grocery store.

As you map your customer journey, try to identify which of your campaigns are most likely to represent a customer’s first contact. Review these campaigns to make sure they present a positive and accurate impression of your brand.

Onboarding

Customer on boarding is the process of teaching new customers what your business is all about. One of the most common reasons for customers to bounce is that they don’t understand your product or service. This feeling of confusion can be difficult to override and is best avoided entirely.

On boarding can be as simple as having a great “About Us” page and making your product inventory accessible to new shoppers. Depending on your company, the process could also involve a sales contact, an email newsletter, or even a chatbot. Utilizing good conversion optimization techniques will typically lead you to an excellent on-boarding strategy.

Growing with Your Customers

All metrics aside, the formula for achieving high lifetime values is straightforward. The more value you offer to your customers, the more money they are likely to spend. Handwritten notes is the perfect example of a way to provide real value that lasts longer than any other form of marketing.

Pricing Models

Your pricing model represents the way customers and clients can do business with your company. The way you price your services can actually have a huge impact on the amount of money a customer will spend over the course of your relationship.

The key to increasing LTV is to avoid having a static pricing model. The more flexibility you can offer, the easier it will be for customers to choose an option that works for them. Consider offering tiered service levels, subscriptions, and even product bundles. Always make sure your pricing model fits in with your company’s existing brand.

Upselling

Upselling is the process of convincing an existing customer to upgrade to the next level of service. Upselling is a great way to increase lifetime value, but it always needs to be done with a gentle hand.

Customers who are ready for an upsell have typically been using your product for a while and are starting to stretch the limits of their current services. Getting the sale might be as simple as reminding them that you offer additional solutions to their problems. If they’re ready to upgrade, they’ll let you know.

Cross-Selling

Cross-selling is the process of selling a customer additional products or services after they’ve already made a purchase. If a customer just bought a pair of shoes and you send them an ad for a matching handbag, you’ve just attempted a cross-sale.

Cross-selling is all about understanding what customers want based on their previous purchasing habits. Cross-selling goes particularly well with remarketing campaigns. Remember not to over-pressure your customers; some people need time between each individual purchase.

The danger of calculating LTV is that is can separate you from the customer experience. On the one hand, it’s important to know how much your customers spend. On the other hand, you won’t make sales if you think of every new client as a potential dollar sign. Use metrics like LTV to make budget decisions. Then, go back to researching and staying in touch with your target audience.