<img height="1" width="1" style="display:none" src="https://www.facebook.com/tr?id=323236494674580&amp;ev=PageView&amp;noscript=1">

What is Lifetime Value and Why is it Important?

By Danny Starr on Jan 29, 2019, 10:21:27 AM

I think every marketer struggles with thinking both long term and short term at the same time.  I believe the reason for this is that we spend a few weeks planning our long term goals/strategies, and the rest of the year chipping away at the mountain of tasks to try and meet them. 

A good way to break yourself out of that short term/long term rut is to calculate and use Lifetime Value (LTV) of a Customer as part of your analysis and planning. 

Why You Should Measure LTV

When working with new clients, the team at Cyan likes to start by figuring out the LTV of their customers.  The reason is that it helps clients understand that there is more to just acquiring a customer.  Calculating LTV forces you to understand how much revenue (and profit) you can earn by keeping customers and/or encouraging repeat business.   In short, the longer you keep a customer and/or help them purchase more often, the more they are going to be worth to your business.

If you have different types of customers, calculating the LTV of each type will help you determine which customers might be important to growth of your business.  For a services business, you might have a client come to you for a one-time project (like a kitchen renovation) or they will engage you for a series of projects over a longer period of time (like a remodel of their entire house).  Because a full remodel client probably has a higher LTV, you'd probably need to focus on those clients or figure out ways you can turn that kitchen reno into into larger, longer-term engagements. 

LTV is also useful for figuring out how you might segment your product and or services for each customer type.  This is something you'll see commonly for software or tech companies.  You might get more personalized service (like in-person support) if you are paying a higher monthly amount for more features.  So an enterprise level client who is deeply integrated with your solution has a higher LTV that somebody who signs up for a low-priced month-to-month contract. 

How to Calculate LTV

The "Quick and Easy" Way

Don't get intimidated by the math or the fact you may not have all  the data you need.  You can do this easily on the back of napkin in a few minutes by figuring out how much a customer spends when they buy, and multiply that by the amount of times they buy in a year.  That gives you an idea of who much they are worth in a year and then you multiply that by the number of years they are expected to be a customer for

This method will give you an approximation of a customer's lifetime value and can be a really useful starting point for you to help frame the discussion around how much you should be spending on marketing, and what your acquisition costs should be.   Let's say you build custom cabinetry for high-end stereo systems.  Your target market is vinyl collectors with higher than average incomes.   They are likely to buy your product once, maybe twice in their lifetime but they'd spend $5,000 on your cabinetry.  Is it reasonable to expect that you're going to acquire customers for $5?  There's no problem setting that type of long term goal but when you're getting started, you might be going to trade shows and spending upwards of $500 to get a customer. 

The "Long" Way

If you want to get a more accurate number and have the data you need to make the calculation, you can calculate it accurately by using the following method:

  1. Take the amount of revenue you made last year from all customers and then divide it by the number of customers.   This gives you the average revenue amount from a customer. 
  2. Then, take the total number of purchases you had last year and divide that by the number of customers.  That gives you the average amount of each purchase. 
  3. Finally, look back into more of your historical data and find out how many years they purchase for.   Then multiply the first two numbers by this and you have your LTV. 

If you find this complicated or confusing, Hubspot provides a detailed overview on their blog.   I also found a few resources mentioned in this Forbes article very helpful.   If you're looking for more info about the "quick way", here's a helpful post with info and if you're looking for more detail, here's a tool from Harvard Business Review that will help you calculate LTV.

Also note that some people include gross margin in their calculation and there's a great discussion about that on Quora

Other Uses for LTV Calculation

When you combine LTV with other metrics you should be tracking, you can do further analysis that will help you make better business decisions.  The best to place to start once you know the top line (revenue) would be to look at your costs, so you should figure out how much it costs for you to acquire customers.   Doing this type of additional analysis helps you get a picture of how effective your marketing and sales activities are... or aren't, and help you establish metrics you can track on an going ongoing basis. 

Customer Acquisition Cost (CAC) tells you how much it costs you to acquire a customer.  To calculate, simply divide your total marketing spend by the number of customers you acquired.  You should try and include as much of your marketing costs, including commissions, as possible to get an accurate idea of how much you're really spending to get customers.

Marketing (and sales) love to understand and justify their role in growing a company and driving the bottom line.  You can take the ratio of LTV to CAC to help determine this.  Obviously, this number should be greater than 1, as you'd hope that your customers are worth more over their lifespan than you're spending to acquire them. 

Conclusions

No matter which way you look at it, LTV is an important metric for you to be tracking for your business.  You can easily use it to align the different departments or resources towards a common goal of acquiring and retaining customers.  LTV can inform decisions on price, product and how you might accelerate your sales funnel. 

If you have any questions about LTV and how it can apply to your business, get in touch with one of our marketing consultants today

Contact Us Today!

Topics: Analysis, Digital Analytics

Danny Starr

Danny Starr

Danny Starr the Director of Marketing Strategy at Cyan. He has been working in marketing since 2001. He spends his free time with his wife Kirsten, their two sons, and their dog Murray.