Lifetime Value (LTV): Learn How to Accurately Calculate This Metric
Have You Ever Wondered What Your Customers Are Worth?
If before you had no idea how to answer this question, in this article, you will learn about an essential metric that will provide you with the answer: Lifetime Value (LTV).
Keep reading the article to understand what this metric is, its importance, how to calculate it, and much more!
What is Lifetime Value?
Lifetime Value (LTV), or Customer Lifetime Value when translated, is an indicator that defines the value of a customer’s lifecycle.
LTV represents the amount of revenue each specific customer will bring to a company (through purchases or recurring payments) while maintaining a relationship with it.
In other words, with this metric, you will know the value of your customer.
Keep reading the article to learn how to calculate it!
Read also: Marketing Reports: How to Create, Metrics, and Templates
The Importance of Lifetime Value for Your Business
Lifetime Value helps you understand the financial health of your business.
This metric directly impacts the future decision-making of your strategies.
Below are some more reasons that highlight the importance of this indicator:
- Shows the connection between your company and its market;
- Indicates when a customer will become profitable, surpassing the investment made to acquire them;
- Identifies which audiences to invest in;
- Represents the spending limit to acquire new customers;
- Encourages companies to shift their focus to the long-term health of their customer relationships;
- Qualifies your customers;
- Helps identify flaws that lead customers to abandon the service prematurely;
- Finds untapped opportunities to improve acquisition and retention.
Beyond all these points, LTV simplifies the calculation of other metrics, such as ROI.
Read also: Is Your Marketing Funnel “Congested”? Discover the Most Common Problems
What Is the Ratio Between LTV and CAC?
In reality, there is no exact answer to this question because every business faces a different reality regarding profit margins, sales volume, and CAC.
However, it’s essential to remember that Lifetime Value (LTV) supports the Customer Acquisition Cost (CAC). In other words, the LTV should always be higher than the CAC.
After all, if your company spends almost the same amount to acquire a customer as the amount that customer spends with your company, you will have no profit.
Pay attention to the following:
- LTV by Profit: If higher than “1,” it means that during this period, the operation covers the cost of acquiring the customer;
- LTV by Revenue: It must be greater than 1.
Read also: Pirate Funnel: The 5 Metrics Used by High-Growth Companies
Learn to Calculate Lifetime Value Without Complications
There are many different ways to calculate LTV, as this metric varies depending on the industry, the types of contracts offered, and the purpose of the calculation (e.g., whether you want to assess the customer’s historical data or forecast future value).
So, don’t worry if you come across other formulas. 😅
In this article, we will show you the most common ways to calculate LTV: a simpler one and a more complex one.
To discover the Lifetime Value of a customer, just plug the numbers into the following formula:
LTV = Average Ticket × Average Purchases per Year × Customer Relationship Duration
For example, if the average ticket of a customer is $300 and they make around 12 purchases throughout the year, over 3 years of relationship with the company, their LTV will be $10,800.
LTV = $300 × 12 × 3 = $10,800
Remember to always use the same time measure in your calculations (days, weeks, months, years, etc.).
You can also apply this formula by calculating the average for all your customers to determine an average LTV for the company.
LTV = Average Ticket × Average Purchases per Year × Average Customer Relationship Duration
However, there is another way to calculate the LTV, providing a more comprehensive view of the business by incorporating additional metrics into the calculation.
Besides the information we used in the previous example, you will also need the following data:
- Gross Margin: Indicates what part of the customer’s purchase is profit and what part is cost. The gross margin can be calculated using the formula:
Gross Margin = (Total Revenue – Cost of Sales) ÷ (Total Revenue) - Customer Acquisition Cost (CAC): The average amount you spend to acquire a customer, including marketing, advertising, discounts, and incentives. The formula is: All Acquisition Costs During the Period ÷ Number of Customers Acquired
In this case, the LTV formula will be:
LTV = (Average Ticket × Gross Margin × Average Purchases per Year × Customer Relationship Duration) – CAC
To simplify, let’s use hypothetical numbers for this formula.
Suppose your company’s average ticket is $300, and your customers pay a recurring monthly fee (therefore, the average number of purchases per year is 12).
Most customers stay with you for 3 years (the average relationship duration is 3 years).
Your gross margin, considering the costs you incur each time a new customer joins the base, is 70% (70% revenue, 30% cost).
Finally, the cost to acquire a new customer (CAC) is $120.
Let’s perform the calculation:
LTV = ($300 × 70% × 12 × 3) – $120 = $7,440
Notice that using the same numbers as in the previous formula and adding gross margin and acquisition cost, we arrive at a lower but more realistic value.
There are still formulas to calculate Lifetime Value that consider Churn Rate, Monthly Recurring Revenue (MRR), and other indicators.
What Does a High LTV Mean?
If your company has a high Lifetime Value, it means that the customer is profitable and that your relationship with them is lasting.
Thus, you can see that your business is succeeding in retaining customers, which is becoming increasingly challenging nowadays.
Read also: How the Pre-Sales Area Can Improve Your Results
What Does a Low LTV Mean?
Now, if your LTV is low, especially when compared to other metrics such as CAC, you need to be concerned, as there is a high chance that your business is experiencing losses.
Therefore, stay alert and keep reading the article to learn tips on how to increase your LTV!
Important Indicators for Monitoring Lifetime Value
We previously explained how important it is to calculate LTV while tracking other metrics simultaneously, as this provides a more in-depth analysis.
Below, we have listed three more metrics for you to compare:
Learn more: 8 Sales and Marketing KPIs Leaders Want to See on Your Dashboard
Churn Rate
The churn rate, or attrition rate, corresponds to the number of customers who cancel your product/service each month.
Pay attention: The higher the churn rate, the lower your LTV will be.
Customer Acquisition Cost
As previously mentioned, the Customer Acquisition Cost (CAC) measures the amount your company is spending on each closed sale.
Remember, the CAC should always be lower than the LTV for your business to be profitable.
Average Ticket
Finally, the average ticket indicates the average amount each customer spends on your products/services.
If your average ticket increases, your LTV will also increase.
7 Tips to Increase the Lifetime Value of Your Business
Now that you know everything about LTV and what it involves, let’s move on to some tips to further improve this metric.
1. Invest in Content Marketing
Whenever possible, invest in creating quality content to attract, engage, and retain customers.
Take advantage of various channels and materials, such as:
- Blog (optimized for SEO);
- Social media;
- Email marketing;
- E-books; and
- Landing pages.
2. Work on Customer Loyalty
Do not treat your customers with indifference; prioritize them, and in return, your company will reap the benefits.
Pay attention to customer relationships, service, product/service quality, and post-sales actions.
3. Have a Customer Success Team
A customer success team goes beyond standard service.
They handle every small detail, ensuring that the post-sales experience occurs in the best possible way.
The main takeaway from this tip is: ensure that your customer is always satisfied with their purchase.
4. Create a Loyalty Program
By creating a loyalty program, you give your customers a reason to keep coming back to your business.
You can offer bonuses for each purchase or implement a points system, for example.
5. Focus on the Most Valuable Customer
First and foremost, identify the customer who brings the most profit to your company. Once you have an answer, focus your efforts on them.
You can create targeted campaigns or personalized content to strengthen the relationship even further.
Also, invest in marketing campaigns to attract other customers like them.
Learn more: Ideal Customer Profile, Persona, and Target Audience: Don’t Confuse These 3 Concepts
6. Bet on Innovation
The market is constantly changing and evolving, especially in terms of technology, so don’t fall behind your competitors.
Invest in continuous innovation, as your customers will keep following the trends.
7. Focus on Service Quality
This tip echoes what we discussed in items 2 and 4.
If your customer has a problem or a question, you need to assist them as quickly as possible and show that you are there to help. Otherwise, they are unlikely to purchase from your company again.
And what’s worse: a negative review reduces your chances of attracting new customers.
We’ve reached the end of another strategic article from Leadster!
After all these explanations and tips, keep an eye on your company’s Lifetime Value and start implementing the strategies we presented here.
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