Lifetime Value or LTV is an estimate of the average revenue that a customer will generate throughout their lifespan as a customer. This ‘worth’ of a customer can help determine many economic decisions for a company including marketing budget, resources, profitability and forecasting.
What is Lifetime Value (LTV)?
Lifetime Value (LTV) refers to the total revenue a business expects to earn from a customer over the entire duration of their relationship. It helps businesses understand customer profitability and make informed decisions about marketing, sales, and retention strategies.
The customer lifetime value (LTV), also known as lifetime value, is the total revenue a company expects to earn over the lifetime of their relationship with a single customer. The customer lifetime value calculation accounts for the customer acquisition costs, operating expenses, and costs to produce the goods or services that the company is manufacturing. Many companies tend to overlook the LTV metric but the lifetime value of customers is essential to the growth of a company.
Formula for LTV
The most basic formula for LTV is:
LTV=Average Purchase Value×Purchase Frequency×Customer LifespanLTV = {Average Purchase Value} {Purchase Frequency} {Customer Lifespan}
Where:
- Average Purchase Value = Total revenue ÷ Number of purchases
- Purchase Frequency = Total number of purchases ÷ Number of customers
- Customer Lifespan = Average duration a customer stays with the business
In subscription-based businesses, LTV is calculated as:
LTV=Average Monthly Revenue per Customer×Gross MarginChurn RateLTV = {Average Monthly Revenue per Customer} {Gross Margin}Churn Rate}}
- Average purchase value – It is calculated by dividing the company’s total revenue over a period of time by the total purchases made by its customers during that same timeframe.
- Average purchase frequency rate – It is calculated by the total purchases made over a period of time by the individual customers that made those purchases during that time.
- Customer value – It is calculated by multiplying the average value of the purchase by the number of times the purchase is made.
- Average customer lifespan – It is the average number of years that a customer continues to buy the company’s goods and services.
- Lifetime value calculation – The LTV is calculated by multiplying the value of the customer to the business by their average lifespan. It helps a company identify how much revenue they can expect to earn from a customer over the life of their relationship with the company.
Why is LTV Important?
- Marketing Budget Optimization – Helps in determining how much to spend on acquiring new customers.
- Customer Retention Strategy – Encourages businesses to invest in long-term customer relationships.
- Profitability Analysis – Identifies the most valuable customer segments.
- Business Growth Prediction – Provides insights into long-term revenue trends.
FAQs
How to increase lifetime value?
Increasing the LTV of new customers by reducing churn will increase the long-term profitability of your company. It is recommended that you have a retention strategy tailored towards different LTV segments in order to reduce churn. If the current expected lifecycle of a customer is six months, you could create packages that are seven months long, or allocate an account manager during the last two months of the lifecycle and step up efforts to increase the likelihood of renewal.
For companies with non-subscription based pricing, one effective method of increasing LTV is to create add-ons that can be up sold to customers in order to increase their LTV.
How is LTV used?
Lifetime Value is a key variable in revenue forecasting, as each additional customer brings additional revenue per month and throughout their projected ‘lifetime’.
LTV can also be used to determine the marketing budget of a company. Adding LTV segments to your customer personas will help you get a better view of the importance of each customer. Specifically, the Customer Acquisition Cost (CAC), the cost of acquiring one new customer, for each segment should always be lower than the Lifetime Value of a new customer.
For example, if a company is considering lowering the price point for one of its product segments, but estimates that the new Lifetime Value of a customer of that segment will be lower than the current CAC for that segment, then creating that price point is an unsustainable business decision.
Another key area where LTV can be applied is resource allocation for current customers. Once you are able to segment your customers according to their LTV, you can allocate more resources towards both the acquisition and maintenance of certain customers. Customers with a high LTV should receive more resources depending on what stage of the customer lifecycle they are in, especially if they are nearing the end of the cycle with potential for renewal.