Lifetime Value (LTV) is one of the most important indicators inside the customer service program. It shows how healthy your business is. When it is big your business model is good, and your company is in the wrong direction when it is weak. In brief, it commonly shows if your business goes the right way or not. LTV can predict to some extent, even the returns of investment data.
LTV is the profit that the company gains from the whole ‘lifetime’ of its customer. The timeline begins from the first order and ends with a final transaction. Understanding LTV can help to determine what exact amount of money each customer can bring to your company’s pocket. What is useful for customer acquisition and what is not in your particular case.
LTV is one of the most frequently used financial indicators for business models, together with MRR (Monthly Recurring Revenue). MRR is often used as a part of SaaS metrics in the B2B market, while LTV can be used in B2C online retail, for example. It perfectly works for every company.
Let us show clearly and simply how to calculate LTV.
Finding Lifetime Value Estimate
LTV is a key to the exact revenue forecast. Each new client must produce a certain amount of income every month during the expected ‘lifetime’. It can also help you to determine the marketing budget. You can find Customer Acquisition Cost (CAS) for each market sector. LTV must be more than CAS. For example, the company plans to decrease product prices. But the LTV in this market segment is lower than the CAS. This short-sighted approach can quickly eliminate your profit and kill your business without changing the current marketing strategy.
If you prefer a realistic approach, you know – money always has its limits. It is still vital to make the right distribution of limited resources among different marketing activities. LTV is the real magic wand to do it. You can separate your clients into several segments based on LTV, and you can focus on the key areas where LTV is more significant to increase the overall profitability of your business.
LTV calculation example
In the Starbucks example, we can see how to calculate LTV based on data from the Kissmetrics study. The report analyzes customers’ purchase behavior for five weeks and then averages the overall value.
And we use this information to measure the average LTV value for Starbucks customers.
Step 1. Average Sale Value
Task result: USD 5.90
Let’s first calculate the Average Sale Value. According to Kissmetrics, the average Starbucks customer spends around USD 5.90 each visit. They divide the money the client pays weekly by the number of visits. For example, if you visit Starbucks four days a week to spend USD 32 your average sales value would be USD 8.
We repeat the procedure after calculating the average sale value for one client. In general, five clients are statistically appropriate. Then we add each average and divide that total by the number of the clients (in this case, it’s five). The result is the weekly Average Sale Value.
Average Sale Value = USD 5.90 = ( USD 3.5 + USD 8.5 + USD 5 + USD 6.5 + USD 6 ) / 5
Step 2. The estimate of the Average Transactions Number
Task result: 4.2
In the Starbucks case, we know how many times the client visits Starbucks every week on average. To find average transactions number divide the sum of each client visits by the number of clients. For five customers, the total number of visits is 4.2, and it corresponds to transactions number.
Average Transactions Number equals Average Visits Number.
Average transactions number = 4.2 = ( 4 + 3 + 5 + 6 + 3 ) / 5
Step 3. The estimate of the Client Value
Task result: USD 24.3
We can calculate the client value based on average transaction number and average sale value. Each of our five clients will be analyzed individually, and the average value of their sales will multiply by the average transaction number. We will see how often a customer goes to Starbucks during the week. Let’s see the formulas and figures. The average client value was USD 24.30 when the calculation was finished for all five customers.
Client 1 Value = Average Transactions Number x Average Sale Value
Client 2 Value = Average Transactions Number x Average Sale Value
Client 3 Value = Average Transactions Number x Average Sale Value
Client 4 Value = Average Transactions Number x Average Sale Value
Client 5 Value = Average Transactions Number x Average Sale Value
Client Value = ( Client 1 Value + Client 2 Value + Client 3 Value + Client 4 Value + Client 5 Value) / Number of Clients
Client 1 Value = USD 14 = 4 x 3.5
Client 2 Value = USD 25.5 = 3 x 8.5
Client 3 Value = USD 25 = 5 x 5
Client 4 Value = USD 39 = 6 x 6.5
Client 5 Value = USD 18 = 3 x 6
Client Value = USD 24.3 = ( USD 14 + USD 25.5 + USD 25 + USD 39 + USD 18 ) / 5
Step 4. The estimate of the Average Client Lifetime (CL)
Task result: 20
Kissmetrics have not specified the estimation method of CL in their study. The report data indicates that the average client lifetime is 20 years for Starbucks.
We need to find out how long every customer stays with Starbucks if we make our calculation with each client data.
So if you don’t have to chase Starbucks clients for the next 20 years, you can predict the Average Client Lifetime. Simply divide 100 by your Customer Churn Rate (CCR) value. CCR is equal to 5% per year in the following example.
Average Сlient Lifetime = 20 = 100 / 5
Step 5. LTV estimate
Task result: USD 25.272
Now it’s time to find out how much Starbucks clients bring throughout a lifetime. We have all the necessary information to do it.
After we calculate both the average client value and the average client lifetime, we use it to determine LTV. First, we multiply the average client value by 52. Why 52? It’s 52 weeks in a year, and we’ve got the results for one week. To achieve LTV, we need to multiply the resulting figure by the average client lifetime (20). The result is perfect (for Starbucks)! The clients have a lifetime value of USD 25.272 based on the data we use.
LTV = USD 25.272 = 24.30 x 52 x 20
A few calculation options for open-minded people
There are several different ways to find LTV for those who want to drive the analysis a little further!
LTV expressed profit
In the same way, you can use profit figures rather than turnover. Simply use your profit received after the sale instead of the turnover data.
To understand your customers’ behavior, you can evaluate LTV for each group, ads, targeting, and so on. You can measure LTV for each advertising channel, a demographic, or a geographic profile. There you have endless options to improve your business using LTV.
If we summarize all of our previous actions using Starbucks data, the algorithm should look very simple. In both measurements, you will have to use the same period — a week, a month, or a year.
A. Calculate Average Sale Value (ASV).
What do we calculate: how much money an average customer spends per average visit or purchase.
Measuring unit: monetary.
How-to: divide the gross margin — total income of your business for a certain period — by the number of sales for one year or one month. For example, you get USD 100,000 in total monthly income and 200 purchases. The USD 500 is the ASV.
B. Calculate Average Transactions Number (ATN).
What do we calculate: how many times an average client visits you or purchases from you within a given period.
Measuring unit: average number of sales or transactions made by a single client.
How-to: divide the number of transactions by the unique number of buyers in a given period. For example, the average number of transactions per month is 200, with 50 single customers. The Average Transactions Number is 4.
C. Calculate Average Сlient Value (ACV).
What do we calculate: how much money the average client brings for the selected period.
Measuring unit: monetary.
How-to: take the first two metrics, the ASV and the ATN from steps A and B. And multiply the Average Sale Value by the Average Transactions Number. For example, the Average Sale Value per month is USD 500, and the average number of transactions is 4. The average value of the Average Client is USD 2.000.
D. Calculate Average Client Lifetime (CL).
What do we calculate: how long each consumer will keep buying in years. It is the period from the first to the last deal.
Measuring unit: years.
How-to: average the number of years that customers make purchases. Or divide 100 by your Customer Churn Rate value. For example, if the Customer Churn Rate is 10% per year, the Average Client Lifetime is 10 years (100/10).
E. Calculate LTV.
What do we calculate: the average amount your customers spend on your business for the entire life of your relationship.
Measuring unit: monetary.
How-to: multiply the Average Client Value by the Average Client Lifetime. Those are values given in steps C and D. In our example the Average Client Value is USD 2.000 per month, and the Average Client Lifetime is ten years. For one year, we measure LTV and one month — ACV. So we have to multiply the ACV by 12, the number of months a year. In total our LTV is worth USD 240.000 (2 000 * 12 * 10).
How to boost LTV value
Often LTV is used to reduce marketing costs by setting the upper limit. This method is also useful in determining the marketing budget for business owners and advertisers because it includes the marketing expenditures for the client.
The LTV value calculation over the entire client lifetime reflects the fact that you should buy a new consumer only once. And the retaining strategy is preferable to an endless new customers attraction.
The existing buyer is already making transactions for several months or years, while the ‘newbie’ is still becoming your client.
The common misconception is to focus on attracting a new client when you budget USD 100 in February. And so you get a new customer who’s going to spend USD 500 in March without scaling and understanding how much we are going to earn from that customer during his entire ‘life’ and not immediately after the initial marketing investment.
Ok, now you know how much money every customer gives you. How can you increase those figures? There are two ways of increasing LTV: customer loyalty and satisfaction, and retention.
Loyalty and satisfaction of clients
Happy customers invest more money. As per HubSpot‘s research data, more than half of companies with high growth announced an investment in better customer support services. And only 29 percent of businesses with stable and growing income have invested in services to improve customer loyalty. It’s easy: the more the money that the company spends on a customer, the more money that the client brings back. Of course, if you spend your marketing money in the right way. For example, you can increase satisfaction by offering discounts to loyal customers and boosting customer loyalty programs.
The new client attraction is not cheap and easy.
It’s not that cheap to attract a new client. According to the Harvard Business Review, it may cost up to 25 times more to attract a new client instead of keeping the old one.
Bain & Company research has also found that a retention cost rise of 5% would boost earnings to 95%! Such statistics demonstrate quite well that the company should focus not only on attraction but also on retaining existing customers. It increases your income and LTV. For example, to retain existing customers, offer additional products as cross-selling or up-selling programs.
Let’s say the restaurant owner wants 100 new visitors. A marketing consultant asks if he’s ready to budget USD 30 for each to launch an advertising campaign. On average, a business owner knows that he profits USD 10 on each client and expects to spend USD 3.000 (USD 30 * 100) but get only USD 1.000. He fires his marketing consultant and so on.
But the owner of the business doesn’t understand the main thing. According to the Bain & Company study, 80 percent of all new clients return on average five times a year, and 40 percent remain your clients for at least seven years.
Also, 25 percent of those ‘old’ clients refer to services or products to their friends, adding even more profit. When it is over, thousands of dollars will be brought to business by the budget that the owner will pay to obtain 100 new clients once.
LTV is the average amount a company gains in a business relationship with an average customer within a whole time of a customer’s interaction with the company. It is one of the most critical parameters for every business model.
Even a small increase in LTV can lead to the income increase (often several times!).
LTV has the same importance as the first conversion to sale.
We cannot guarantee that it is easy to increase your LTV. But we hope that you will continue to fight for LTV high value even if you have not done it before. You would be surprised how high LTV will increase your income! Good luck.