What is Lifetime Value?
Lifetime value (LTV) is an ecommerce metric used to measure the average duration of customer relationship with the company. It is calculated by taking the average time between the first and last purchase made by a customer. This metric is important in driving CRM (Customer Relationship Management) decisions, as it allows us to understand how long customers remain loyal to our business.
Formula
There are many methods of calculating CLV, depending on what data you have available:1) Accumulated data method: CLV = Order 1 + Order 2 + Order 3 +……+ Order n (where n is the number of orders)2) Average estimation method: Average order value (AOV) *Average purchase frequency*Average customer lifetime3) CLV based on historical sales data: AOV x Frequency of purchases x Margin(Margin = AOV – COGS – Average Overhead)
Example
Let’s assume the example of an online bookstore. Here’s how you might calculate CLV based on historical sales data:Suppose the average customer spends $30 each time they make a purchase from your online bookstore. Also, the average customer makes a purchase once every two months. That’s six purchases per year.COGS (Cost of Goods Sold): This is the direct costs attributable to the production of the goods sold in a company. In this case, it could be the book’s wholesale price, shipping cost, etc. Let’s say that this amounts to $20 for the average order.Average Overhead: This includes other costs to run your business, such as marketing, salaries, utilities, rent, etc. It can be challenging to allocate these costs to a single order, but for simplicity, let’s say that these average out to $5 per order.Now, we can calculate the Margin as follows:Margin = AOV – COGS – Average OverheadMargin = $30 – $20 – $5Margin = $5We can then use this Margin in our CLV calculation:CLV = AOV x Frequency of Purchase x MarginCLV = $30 x 6 x $5CLV = $900
Why is LTV important?
Lifetime value (LTV) is an important metric in terms of customer retention. The longer the customer is engaged with the company, the more value they can bring. Higher LTV can be beneficial for customer acquisition, as it indicates that our customers are likely to remain loyal to our business over an extended period of time. It can also be used to identify areas where customers are not finding value, as well as opportunities to deepen relationships and increase customer loyalty.
Which factors impact LTV?
There are several factors that can impact LTV. These include customer satisfaction, customer service experience, product quality, pricing, customer interaction, and competition. By paying attention to these metrics, companies can gain insight into how to improve customer relationships and keep customers loyal over extended durations.
How can LTV be improved?
There are multiple ways businesses can improve customer lifetime value. These include increasing customer satisfaction, optimizing product quality and pricing, providing excellent customer service, and using personalized marketing techniques. Companies also need to invest in technology to ensure seamless customer interactions, such as chatbots and automatic emails. It is also important to monitor customer feedback to identify areas of improvement and create loyalty programs to encourage customers to continue engaging with the business over an extended period.
What is LTV’s relationship with other metrics?
Customer Lifetime Value (CLTV) is interconnected with several ecommerce metrics. It’s directly proportional to Average Order Value (AOV) and Repeat Purchase Rate, as higher values for these metrics enhance CLTV. Conversely, Customer Acquisition Cost (CAC) and Churn Rate are inversely related to CLTV; lower values result in greater CLTV. Customer Retention Rate also impacts CLTV; higher retention equates to more purchases, thereby boosting CLTV. Furthermore, CLTV significantly affects Return on Investment (ROI). Understanding these relationships can guide effective strategies for customer relationship management and business growth.
