What is the lifetime value of a customer – and how can you increase it? When entrepreneurs are just starting, they focus on acquiring customers to make a sale — period. But to grow your business and thrive in the long term, you need to set your sights past that first sale and far into the future; you need to start tracking your customers’ lifetime value (LTV) and determine what’s a good LTV for your business. If you don’t know how to get started, we’re here to help.
Learning About LTV
So, what is the lifetime value of a customer? The lifetime value of a customer (or LTV) is a prediction of the revenue that a customer will bring your business for as long as they continue to be your patron.
If all goes according to plan, a customer will never shop with you only one time. In a perfect world, they’ll become your customer and love what they bought so much that they’ll continue to use your services or buy your unique products repeatedly. They might even buy them for other people too.
This ongoing relationship and the money that results from a string of sales over time is that customer’s lifetime value or LTV.
Knowing your customers’ LTV is important because it will help you set a marketing budget to acquire new customers. If you know each customer has a lifetime value of roughly $1,000, you can better predict future revenue and determine how much you can afford to spend than if you just looked at how much money was in your bank account today.
Defining a customer’s LTV also enables your marketing team to make better decisions about what strategies to use to either increase retention or acquire new customers as the others begin to churn.
The important thing to remember when it comes to LTV is you’re calculating how much a customer will spend with you over time, not how long they stay. Ultimately, LTV is a numeric variable used in a financial calculation.
So, what is the lifetime value of a customer at your business? We know LTV is the amount of money a single customer will spend with our business over time, but how do we calculate that number?
There are many methods to calculate LTV, but we’ll focus on the most commonly used formula.
First, you must gather a few pieces of information before we can crunch numbers. To calculate your customer LTV, you’ll need:
- The average value of a sale at your company: Some KPI tracking softwares will tell you this number, and if they do, that’s great! But if you’re calculating it by hand, it can be tricky since each customer likely spends a different amount when they buy. If you’re calculating LTV per customer, simply average their sales together. If you’re finding the average LTV for all your customers, we recommend taking a group of random sales over a specific period (like a month) and calculating the average. Typically, these transaction values should fall close to each other, with only a few outliers.
- The number of repeat transactions each customer makes: If you want to calculate revenue by each year, it’s important to evaluate how many times a customer shops with you in a year. So, if a customer uses your services once a month, that’s 12 repeat transactions. Again, the broader you go with your calculations, the trickier this gets. If you’re trying to find the LTV of a single customer, you can just count how many times they’ve purchased from you in a year (or whatever time frame you’re measuring) using your KPI tracking, accounting, or sales software. If you’re trying to find the average repeat transactions for all your customers, you’ll have to do some averaging magic again.
- The average time you retain a customer: This is not your customer retention rate but the actual amount of time you retain a customer. This value may be a little harder to figure out by hand, but you can use your metric or sales software to see how far back a customer’s transactions date. If their first sale with you was in 2017 and they dropped off in early 2021, you retained that customer for four years. Again, if you’re trying to find the retention time of your customers as a whole without the help of fancy software, you’ll have to do more averaging magic.
Now that you have your numbers prepared, we’re ready to start calculating! To find a customer’s (or the average of all your customers) LTV, follow this formula:
The average value of a sale at your company X the number of repeat transactions a customer makes multiplied by the average time you retain a customer = your LTV
For example, let’s say you own a bike shop, and one of your customers spends $15 on parts twice a month for seven years. That means the customer’s LTV would be $2,520 (15 ✕ 24 ✕ 7 years).
It might look a little different if you want to find the average LTV for all your customers. Let’s say the average value of all your monthly sales was $149.57, and (on average) each customer buys from you 2.3 times a year for 5.7 years. The average LTV of your customers would be $1,960.86 (149.57 ✕ 2.3 ✕ 5.7). So some customers may bring a little more, and some may bring a little less in their lifetime, but on average, you can anticipate each customer will bring $1,960.86 in revenue to your business.
One crucial thing to note here is this is not the profit you will make from each of these customers — just revenue. So once you account for expenditures, each customer’s profit is a little lower.
CAC And LTV
When using metrics like LTV to determine your future marketing budgets, it’s important to consider each customer’s acquisition cost (CAC).
The reason is that if your customers are more expensive to acquire than they’re financially worth for your business, it’s probably a good idea to adjust your budget or strategies so you’re not losing money in the long run.
CAC and LTV are often used together, and once a business calculates one, the next step is to figure out the other. Just like revenue and expenses show a profit, CAC and LTV give you a peak inside your company’s current spending and financial future.
Your CAC is calculated as the total cost of acquiring customers divided by the total number of customers you gained over time. The “cost” here is the total amount of money you spend on sales and marketing to acquire those customers.
So, let’s say you spend $5,000 a year on marketing targeted at acquiring new customers, and you successfully acquire 35 new patrons from your efforts. That means each of those 35 new customers you wrangled costs your business $142.86.
Once you know your CAC and LTV, the next step is to calculate their ratio to one another. It’s important to know this ratio because it will show how much you spend on your customers versus how much revenue they bring in return.
To find this ratio, divide your LTV by your CAC, and voila!
If we use the LTV from our earlier example, the LTV of $1,960.86, and divide it by the CAC we found above at $142.86, we get 13.73, which is a great CAC to LTV ratio. That means with that revenue and cost, each customer is worth nearly 14 times what was spent to acquire them.
Ideally, your CAC to LTV ratio should always be above 3.
Anything under 3 means you’re probably losing money in your marketing efforts, and it’s time to adjust your strategy.
Aside from being a key indicator of when you’re spending too much money with an insufficient return, understanding your customers’ LTV matters for a few reasons.
It Helps You Make Marketing Decisions That Win.
We all wish money grew on trees, but the truth is that it doesn’t, and small businesses don’t always have the capital to blow on expensive marketing campaigns. Being familiar with the LTV of your customers allows you to visualize the best way to allocate your spending based on future revenue. If you know the LTV of your customers is $5,000, deciding the budget for new initiatives becomes easier because you can anticipate what you can afford to spend and how much revenue the new customers you acquire will bring you.
It Spotlights Your Best Customers.
We mentioned before that many values you calculate will probably be similar, but there will always be a few that stand out, like a customer with a lifetime value far above the rest.
If you notice one of your customers shops with you more frequently or spends more money than the others, their LTV will be much higher. When you can shine a light on your loyal customers with higher LTVs, your customer success team can focus their retention efforts there to ensure they stay your customer for a longer period.
These customers are also a great source of insight into what your business is doing right. Reach out to them and see if they can offer any feedback on how you can improve your customer experience.
Creating A Good LTV
People want a definite answer on how to do this, but the reality is that a good LTV is different for everyone, depending on their goals.
If you’re a small business, like a local pet store, you might have a lower customer LTV but hardly have to spend any money on marketing, as new customers find your business frequently. In this case, having a lower LTV isn’t necessarily bad since you’re selling essential commodities that move quickly, regardless of how long a customer stays or spends over time.
But if you’re a large e-commerce company selling podcast content, and your customer LTV is low, it might be a bad sign since customers may be more infrequent and expensive to acquire.
Ultimately, you know your business better than anyone. If your goal is to earn more money year after year, a high LTV is probably best because that means customers are spending more, shopping often, and staying around.
If your goal is to add value to your community and focus more on engagement than revenue, a low LTV might not be a cause for concern.
Boosting Your Customer LTV
Now that we’ve answered the question, “what is the lifetime value of a customer?” it’s now time to discuss how to raise it. If you’ve calculated your LTV and it’s not where you’d like it to be, you can take a few steps to improve it.
Make The Customer Experience Personal.
At its root, LTV is about your relationships with your customers. If they like your brand, they will spend more, shop often, and stay longer. The easiest way to do this is to ensure your customer experience is personalized and helpful, so every time your customers interact with your business, they’re left with a positive experience that makes them want to shop more.
Engage Customers With High-Quality Content.
If you provide your customers with high-quality content that adds value to their lives and doesn’t shove aggressive sales marketing down their throats at every turn, your brand will become a trusted source of information for consumers. The more your content instills trust and keeps buyers informed, the more people will stay engaged and have your brand in mind.
Spend Time Nurturing Your Customer Relationships.
We talked about focusing on your customers with higher LTVs, and while it’s important to nurture those relationships so your big spenders, well, spend more, it’s also important to boost all of your customers’ LTVs by taking time to nurture your relationship with them. Keep in touch with your customers by sending out cards, emails, newsletters, or whatever it takes to let them know you have them in mind.
So what is the lifetime value of a customer? Well, it’s just a measurement of how much revenue a customer, or an average of customers, brings your business. The important thing to remember is more than fancy software or crunching numbers, LTV is about the meaningful relationships and experiences you create that drive your customers to spend with your brand.
We have the perfect tool for you if you’re ready to boost your customer LTV to master your marketing. Newsletter Pro helps clients make their customer experience personal, engage customers with high-quality content, and nurture their relationships with customers, all key factors for boosting LTV. Our Content Marketing Guide is full of expert tips, tricks, and strategies to help boost your content engagement levels. This will even increase your customer LTV — something we should all strive for.
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