Lifetime Value: What It Is And How to Calculate It

Companies often repeat the mantra that every customer is important because they have made at least one order. But will this purchase pay back the cost of attracting a customer? What is your actual spending on a single customer during the whole time you’ve worked with them? The LTV metric will show if the company is profitable to work with the client, or if their attraction, engagement, and retention will take away the budget in deficit.

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What is LTV and why your business needs it?

When a customer buys for the first time, we don’t know if they will buy again and become a regular, or if they will leave right away. If you know the entire customer journey, you can allocate the budget wisely: you should prioritize spendings on clients who will buy more than once over one-time customers. Lifetime Value (LTV) helps you predict this path.

LTV is the total profit from the client during the period you are working with him. The essence of the metric is to show whether the cost of attracting, engaging, and retaining such a client is justified. If we already know how much a certain type of client spends, then when calculating LTV we can predict the exact amount of spendings for a specific group of clients. Metrics are used as a benchmark and reference point.

If you search on Google for what LTV is, you will find other names for this metric – CLTV and CLV. There is no difference between the definitions of these metrics, so it is no mistake to use either name.

LTV can be calculated with different time data:

• Historical LTV – we take customer data regardless of whether the company cooperates with him now or not. With this information, it is possible to predict the behavior of current users. The approach is useful if the customer is initially approaching the business for a short period of time, such as one-time order of custom writing, driving school, and other temporary collaborations.
• Predicting LTV evaluates existing and new users, and helps identify customers who at this time can bring you the most profit.

Why do businesses need to calculate LTV?

Learn customer behavior and personalize offers. Understand how and what kind of order they usually make first, when they make repeat orders. Based on this info and data valuation findings, think of a strategy and push the customer to action at the right moment.

Find loyal customers and develop separate strategies for them – those who buy more at once or order a little but often. Determine which group of customers are not worth spending resources on.

For example, customer N bought once for $500 but did not make more purchases. There is a client S who orders $200-250 every month. Despite the lower average check, the total profit from client S is greater than from N.

Optimize the work with clients – to see the moment when clients leave or start buying less and return the activity. For example, adjust ads for the target audience that stopped coming to the service, or do a mailing list.

Find out which advertising channels bring in more valuable customers and optimize your budget for them. LTV helps to calculate the effectiveness of channels in the long term.

For example, clients from Google Ads usually do not buy immediately, but make purchases 1-2 weeks after their first click for $100-200 every quarter. And customers from Facebook ads buy immediately for $300, but disappear and rarely order again. In the long term, campaigns in Google Ads attract more valuable customers

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8 ways to calculate LTV

1. LTV = Income for a certain time / All clients for that time.

It’s a simple LTV formula, but you can’t call it accurate, because the calculations are approximate. You can not take into account users who have not yet bought anything but have already interacted with the brand.

2. LTV = ARPU x Lifetime

Here you have to calculate other metrics beforehand:

Lifetime – the time during which the user actively uses the product or service: from the first order to the final collaboration.

ARPU – profit (average value) from the client for a certain period of time. Calculated by the formula: regular income/number of customers for a certain time.

3. LTV = Lifetime x RPR x AOV

A more complex and advanced formula for Lifetime Value, where you also have to calculate additional metrics.

AOV is the average order value.

RPR – Repeat purchase rate; the index that shows how often the client buys repeatedly.

Lifetime – the time of the user’s active cooperation with the brand.

This formula is more suitable for predicting business growth for the short term.

4. LTV = F – T.

An elementary formula where:

F – income from the client.

T – the cost of attracting and retaining this client.

The formula does not take into account many factors: growth in the number of customers, price changes

5. LTV = (Transaction 1 + Transaction 2 + … + Transaction N) x Profit share

Here you have to first calculate the net profit: without the cost of attraction, retention. Then find all the transactions and sum them up. The method is long but accurate.

6. LTV = ((T x AOV) x AGM) x ALT

In this formula we will have to collect enough data and calculate the following indicators:

T – number of sales per month (average).

ALT – average lifetime; period of cooperation with the user in months.

AGM – average gross margin; profit for a certain period.

This method helps to make a rough prediction of CLTV.

7. LTV = AGM x Number of purchases for the chosen period x AOV x Lifetime

A simple formula to calculate, but time-consuming to collect data:

The time spent on the calculation is justified by the accuracy of the results.

Calculating LTV through cohort analysis

Cohort-based LTV is calculated by companies that want to study their customers’ behavior in detail. A cohort is a group of users who took an action (purchase, subscription, etc.) during a certain period. Cohort analysis will show which groups stay with the brand longer, from which sources they come – the results are used to make conclusions about the effectiveness of channels, to optimize strategies and budgets.

If a client hasn’t been buying for a while, it doesn’t mean they’ve stopped working with the brand altogether. Counting activity, customer reactions to brand messages will show whether a customer is active or not anymore. But it’s hard to manually gather that kind of data, especially from different marketing channels.

Marketing automation platforms (Altcraft Platform and others) simplify the task for marketers – data from all available channels are collected in one LTV report. User activity is analyzed by the number of clicks on links in notifications for managers, transactional notifications, in the mobile app, and promotional mailings. A blog subscription is also considered an indicator of activity.

The LTV can be viewed on the graph and you can determine the loyal customers – the most active users.

In such services, you can see the dynamics of customer activity by day, week, or month. This report tells you where activity is dropping, and where you can focus your resources to retain clients before they leave for another brand.

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How to increase LTV

There is no single correct and universal value for customer LTV. Each company calculates it individually. What to do if the LTV is below the norm? There are ways to fix it.

Increase one of the indicators

It is enough to change the average check, the frequency of purchases, or the lifetime of the customer for LTV to increase. To do this, you need to improve communication with the customer.

What tools can be used:

Email newsletters – if you know how to start an email to get a potential customer interested, newsletters are a good way to remind yourself, make a personalized offer, or remind you about items in your cart.

Push notifications – messages to the browser or a pop-up window in apps on smartphones. If a user gives you permission to send it, you can, as with Email, offer them discounts, remind them of an unfinished order, notify them of a price reduction on the items they’ve reviewed. Push has an obvious advantage over Email – they’re harder to miss. An email can get lost among dozens of others. But a user can turn off Push-notifications, so don’t put all your efforts into one channel.

Loyalty programs – great personalized offers, bonuses, and discounts increase the average check and keep the customer coming back. Especially when offers are limited and you need to buy now.

Work with regular customers – it’s more profitable to keep the loyalty of “old customers” than to attract new ones. Special offers, free shipping, gifts, and other bonuses are the key to loyalty and long-term relationships.

Retargeting – advertising to an audience of users who have already interacted with your brand: came to the site, social media pages, left data. Retargeting reminds them of the company or the products the user was looking at. It creates the effect of presence everywhere – it is beneficial for the brand: when the user has a need for a product or service, they will be the first to remember your brand.

Cross-selling. Offering related products are important. Not only because you need to increase the average check. Buying a useful additional item can increase customer satisfaction. For example, if when buying a table lamp, you reminded them about the bulbs that weren’t included. Or about the batteries for children’s toys. Such an offer is not perceived negatively, because this is caring for the customer.

Improve the customer experience

Every customer contact with your company leaves an impression: calling tech support, making a purchase, visiting the store, using the purchase, even viewing ads on social media. If a customer has had a negative experience at any stage, they probably won’t go any further. Improving the customer experience can be helped by monitoring the quality of service, investigating customer complaints, and educating employees.

Properly handled negative feedback will save the company’s reputation and even turn a disgruntled user into a brand advocate.

Simplify adaptation

Relevant for apps and services. If a user has to go through 9 circles of hell before they get what they need from your service, they’re more likely to leave right away. When it’s hard, the most motivated will stay. Simplify the beginning of using your product or service. Proper onboarding is a clear and easy help section, tutorial videos, tooltips, and quick support reactions to a user’s problem.

Conclusion

Counting LTV for a business is a long game. Plan your budget in advance for all customer outreach, not point campaigns, and know where the weak spots are in attraction and retention. LTV can’t be called an unambiguous metric because of the different ways of calculating it, where there is no perfect one. But companies that account for customer lifetime gain more in the long run because their business becomes more predictable.

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