What is Customer Lifetime Value (LTV)?
Customer Lifetime Value (LTV) is a calculation of how much money a customer has spent with your brand. For eCommerce brands, this is a vital metric that reflects the health of the business and informs decisions such as customer acquisition and customer retention. Even though LTV is one of the most important eCommerce metrics, it is also one of the most commonly miscalculated ones: LTV is the gross margin per customer over their lifetime with your brand.
LTV is often miscalculated as the total sales or predicted sales value. Respectively, these metrics are are lifetime revenue (LTR) and predicted revenue. Many companies rely on these miscalculations due to misunderstanding how to calculate LTV, and they harm their brands in the process.
How to Calculate LTV
Example of an LTV Calculation:
Let’s say in January of this year, you acquired 1000 customers. Then, if your average revenue from a customer’s first order is $50, and you take out your product costs, you’re left with $30 of gross margin. So, your initial gross margin from those is $30,000 (1,000 customers * $30 Gross margin/customer).
Over the next 12 months, 25% of these new 1,000 customers return to your site and make another purchase, bringing in another $30 in gross margin per customer (1,000 customers * 25% repurchase rate * $30 gross margin per customer = $7,500).
Plugging the numbers into the LTV equation: Your 12-month LTV for this group of 1,000 customers is going to be the initial $30,000 in gross margin + the $7,500 in repurchase gross margin, divided by the total number of customers:
($30,000 + $7,500)/1,000 = $37.50.
Here's a visual of how to calculate LTV in this situation:
What’s the right time period to measure LTV?
There are a number of right answers to this question. Many factors will play into it, like frequency of purchase, seasonality, or how much change your industry might be projected to face in the coming years. Many businesses measure LTV in 6-, 12-, 24-, or 36-month windows.
Businesses with very long purchase cycles, such as mattress brands, would likely use a much longer time period. Ultimately, your LTV calculation should be based on your company and industry.
The importance of LTV and ways to segment customers
Understanding how valuable your customers will be to your business over time can help you understand how much to spend to acquire them. If we stick with the example above, knowing there is $30 of gross margin in someone’s first order might mean your brand can spend up to $30 dollars to acquire a new customer.
But wait, it gets much more exciting than that!
Aside from downloading your entire customer database and calculating LTV in Excel, you can do more sophisticated analyses by different cohorts and uncover where you should invest more or less, based on each cohort’s spending behavior.
Here are a few different LTV customer segmentation strategies:
LTV by Acquisition Date
A common way to look at LTV is by the quarter the customer was acquired. Check out the chart from Daasity’s LTV dashboard below.
In this example, you can see LTV increasing at a fairly steep rate. Each quarter (represented by a different colored line) starts out a bit higher, meaning that the brand is increasing its LTV.
LTV by Marketing Channel
This is a really important LTV calculation, and it might have you thinking twice about how your budgets are allocated. Just as all customers don’t have the same purchasing behavior, customers acquired through different marketing channels don’t perform the same and may have extra costs that should be factored in.
Segmenting customer LTV by marketing channel can be insightful because you may find a trend that may change how you allocate your budget. For example, you might find that customers acquired through Channel A actually spend more money on their first purchase than customers acquired in Channel B.
If we go back to our earlier example, perhaps the average first purchase is $50, but Channel A customers might spend $60, and Channel B customers might only spend $35. Knowing that, you’d want to try to acquire more customers from Channel A—potentially, by allocating marketing spend from Channel B to Channel A.
LTV by First Product Purchased
Another way to calculate LTV is at the product level. Customers who buy a certain category of products may have much higher LTV than average. If you find that this is the case for your brand, you want to both try to understand what characteristics make up that group of customers and also give that product more exposure in your store.
Bonus: How to Increase LTV
As shown in the last two segmentation strategies, eCommerce brands can maximize LTV by working to acquire more customers from more lucrative marketing channels and by better understanding customers who purchase particular types of products from your brand.
However, there are numerous other ways to increase LTV. Consider trying some of these strategies:
- Optimize your customers' shopping experience to offer compelling upsells ("Do you want a 10-pack instead of a 6-pack?"), cross-sells ("Would you like these complementary socks with the pair of shoes you're buying?), and product bundles ("Customers often purchase Y, Z, A, and B with X").
- Introduce product line extensions. Can you offer a luxury or upmarket version of a product you sell? Can you add some modifications like a new flavor, organic version, new style or color options, or increased functionality? This can increase the value of new customers' first purchases over time.
- Offer free shipping (or free shipping with a minimum purchase total). Customers love free shipping, and encouraging them to spend more to get it will boost the value of their first purchase along with average order value (AOV).
- Keep close tabs on your social media channels. Customers may @ your brand with complaints (or suggestions!), and by answering questions directly or directing them to the appropriate resources, you can build loyalty, which will increase LTV over time.
- Personalize the customer experience. For example, can you implement targeted pop-ups depending on what channel a customer is coming from? Or, can you improve your CS team to solve potential customer problems through SMS, or their preferred contact method?
- Implement a loyalty or rewards program. Making customers feel special, offering compelling rewards and points systems, and building loyalty among them will increase the chances they will continue buying from you over time (which means a higher LTV!).
- Offer a subscription option. If you sell items that can be sold through a subscription model (e.g., beauty products, certain home goods, food or beverage, among others), a subscription can increase the amount of time a customer spends with your brand. If you offer annual or longer-term subscription options, you'll also have guaranteed revenue.
Final LTV Thoughts
If you made it this far, then you know how to calculate LTV: divide gross margin by the total number of customers during a time period: usually over 6, 12, 24, or 36 months. You also know three ways to segment your customers:
- By customer acquisition date
- By marketing channel acquired
- By product
And, you have a bunch of ideas about how to increase your customer lifetime value.
Now, you can better allocate budgets, spend more to acquire more valuable customers, and even avoid less valuable customers. However, if you need assistance determining customer lifetime value for your brand, we can help: you can talk to an LTV expert today.
Daasity is transforming the way companies access and use their data. It is the first and only company to design a data analytics platform specifically for the direct-to-consumer industry that makes business-critical data accessible and usable for strategic decision-making. Daasity’s mission is to make business-critical data accessible for all DTC brands. For more information, visit www.Daasity.com.