What is Customer Lifetime Value (LTV) and why does it matter?
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. To be clear, 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 are the metrics 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
LTV Calculation Example:
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.
Check out the visual representation below:
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 mattresses, 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 could 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.
Note: TOB = Time on Books = how long these people have been customers
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 their LTV.
Brands can boost their LTV by optimizing their sites for increased upsells, changing prices, introducing a product line extension plan that increases the value of new customers’ first purchases over time, among other strategies.
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.
If you made it this far, then you know the LTV equation is gross margin divided 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
If you know how to calculate LTV, you can better allocate budgets, spend more to acquire more valuable customers, and even avoid less valuable customers.
If you need assistance determining 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 proprietary 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 or LinkedIn.