The process of acquiring new customers and retaining existing ones requires a lot of work in terms of understanding, as well as implementation of knowledge gained and current best practices. Fortunately there are various solutions at your fingertips; one such solution is the customer lifetime value metric (LTV).
Let’s be honest. Many of today’s marketing protocols yield fleeting results, or quickly become redundant when powerful, consistently accurate metrics are devised. Arguably the smartest strategy is to jump in at the deep end, familiarising yourself and your teams with demonstrably successful modern metrics that facilitate the deepest insights over the long term.
In this article we will explain what the customer lifetime value is, why it’s important and how to do a customer lifetime value calculation.
What is customer lifetime value?
To summarise, customer lifetime value is a business metric that allows you to determine the amount of revenue you are likely to gain from each of your customer’s accounts. This metric helps you to accurately predict the revenue value of each customer, after which you can compare this amount to probable lifespan of the customer. You will then be in a position to determine significant customer segments, essentially identifying who brings the most value to your business.
In other words, customer lifetime value is your tool for assessing exactly how much revenue any given customer is likely to generate across the time frame they interact with your business. Customers who spend the most over the longest period of time will have the largest lifetime values.
Your customer service and sales teams will be able to use the findings generated by the metric in order to devise successful ways of encouraging customer loyalty. Problems (and customer pain points) can be more easily identified – especially through the customer journey mapping process. This helps you to offer more value to your customers in a win-win cycle that, when effective, results in higher LTVs.
Why is customer lifetime value important?
Customer lifetime value is very important, as understanding it leads to greater customer satisfaction and consequently retention. Each customer lifetime value calculation can make this goal a lot easier, since it highlights the probable state of affairs and therefore the areas that need work. As it is absolutely vital that you consistently nurture and provide optimum value to your best customers, knowing where you are at with each one and how long they are likely to stay loyal to your brand is key.
Here is another reason that customer lifetime value is important: we know it’s not exactly rocket science, but the higher the LTV number, the greater your profits will be. There’s no getting around the fact that customer acquisition is going to cost money, as covered in our article on calculating the cost of customer acquisition. The same goes for customer retention, although that generally costs less than acquisition – five times less, to be precise.
The bottom line is that (as with anything in life) in order to improve something you first have to get an accurate measure of the situation, and customer lifetime value calculations help you do just that.
How to do a customer lifetime value calculation
You can calculate customer lifetime value by following the five steps below:
1. Calculate the average purchase value by dividing the total revenue generated by the business by the number of purchases made, during a predetermined time frame of your choice.
2. Calculate the average frequency of purchase rate by dividing the amount of individual purchases by the number of individual customers purchasing throughout the determined timeframe.
3. Calculate the customer value by multiplying the average purchase value (1) by the average frequency of purchase rate (2).
4. Calculate the average customer lifespan by finding the average number of years the customer has continued to buy from your business.
5. To calculate the LTV, you will need to multiply the customer value (3) by the average customer lifespan (4). You will then have an approximate figure corresponding to expected revenue generated by an average customer throughout their interaction with your business.
We know this might be a little confusing, which is why we have created a tool to help our readers shortcut to the figures. You can use our free customer acquisition cost calculator to determine both the cost of customer acquisition and the customer lifetime value too. We hope you enjoy using this tool, and don’t forget to take a look around the site for other useful advice on successful customer acquisition and retention.