Estimating the lifetime value (LTV) of your customers requires that you have accurate data on your marketing and advertising costs and that you know what your customers spend. Large corporations make big decisions based on LTV all the time, but LTV is equally valuable and useful information for any size business.
Lifetime Value Definition
Lifetime value is a marketing term. It's also called "customer lifetime value" or "lifetime customer value". As if three synonymous terms weren’t enough, it's also sometimes referred to as “life span” instead of “lifetime.”
These terms all mean the same thing. They refer to a calculation that can help you determine how much profit you’re making from your customers versus how much you’re spending to get and keep them. The calculation can be made per individual customer or as an average. The average method is the most useful for making predictions and decisions for your business.
In this context, customers’ lifetimes or spans are not about their ages or health; they're about the length of time they are customers of your business. A customer’s lifetime varies a lot based on many factors. A major one is the type of business you have. Customers of a plant nursery may have an average life span of several years, but bridal shop customers usually have a very short life span.
Lifetime Value Calculations Using Averages
There are many ways to calculate LTV, but every method has the same purpose. It's to help you see what you spend attracting and retaining customers versus what you make from them. For an LTV calculation to be truly useful, it should include a specific time frame. There are three ways to calculate your business’s average LTV, and the first two include specific time frames:
- For a year, a quarter or a month, multiply the average amount of a sale by your customers’ average repeat purchase rate (how many times they return to buy more items). Multiply that by the number of customers you had during the same time frame and then subtract the amount you spent acquiring and keeping those customers just before and during the same time. This equation gives you sales versus costs and doesn’t drill down to profits.
- Start with the amount of profit you made during a finite period of time and subtract what you spent during that same period of time attracting and keeping your customers. The result is the lifetime profit value of all of your customers during the period of time you chose.
- Multiply the average profit you make per customer by the average number of years they remain your customer and then subtract the average amount you spend acquiring and keeping them. This calculation gives you a broad overview of your business's LTV.
All of these equations are based on historical data from your business. If calculated regularly, LTV will reveal trends and tell you when and how you’re getting the most bang for your buck.
Lifetime Value Calculation Example
You rent kayaks on a beautiful, pine-studded lake during the summer. Customers reserve and pay for the rentals on your new website. The average customer rented a kayak for two hours at $20 an hour and came back three times, and you have 300 customers total. At the start of the summer, you spent $2,000 building the website for your customers’ convenience.
Using method one above, your LTV calculation for June, July and August would look like this:
Your average sale of $40 multiplied by the return rate of three equals $120; multiplied by 300 customers this is $36,000. Subtract the $2,000 cost of your website. The $34,000 remaining is your LTV in sales for last summer. For net profit LTV, you’ll have to reduce the $34,000 by the costs of running the business, like kayak repairs and new paddles.
Tweaking Lifetime Value Calculations
You’re either nodding off by now or your mind is spinning with the possibilities of applying LTV to your business. If you’re the former, grab a latte with a few extra shots and hang in there because LTV can help you make all kinds of wise decisions for your business.
The more factors you include in your LTV equations, the more precise and helpful the answers will be. For example, instead of using overall average sales and profit numbers, you can segment your customers into three groups according to what they spend and how much you spend on each group. Then, run the numbers for the big, medium and small spenders. This can help you see if you’re using your customer attraction and retention dollars on the right customers.
You can calculate the lifetime value of a particular customer. We all have at least one who we’ll affectionately call “high maintenance”. Every time that customer comes in, your staff sighs a collective big sigh and wonders if he’s really worth all the extra work. Run an LTV calculation on him and find out.
Uses for LTV
One business maxim is that it’s less costly to keep customers than to acquire new ones. Growth is often equated with more new customers. However, over time, it's been proven that more profit is made from regular customers than new ones. If you want to see for yourself, run your LTV numbers for existing customers and run it for new ones.
In addition to helping you determine how much to spend retaining customers versus getting new ones, LTV can help you decide whether to expand your product line or services. It can help you decide what types of customers you want to cultivate and how much you have to spend on them to get optimal results.
Lifetime value of a customer can be a prediction of:
- Average net profit for the lifetime of a given customer
- Average net profit for the lifetime of all your customers
- The lifetime of your business
The Cost of Customers
The costs you incur getting and keeping customers includes the obvious, like marketing and advertising. It also includes things like:
- Loyalty rewards programs
- VIP rewards programs
- Money you spend improving customer service, like the cost of developing an app
It’s anything you spend for the purpose of attracting new customers and/or keeping the ones you have.
It’s All About Your Data
You’ve probably noticed by now that for any lifetime value calculation to work, you need good data, not just guesstimates. Remember that you’re going to make some important decisions based on LTV, so it’s important to get it right.
If you’re going to use LTV, and of course you should, there’s no way around collecting and tracking data. The more detailed your data, the more accurate and detailed information you’ll get from your LTV calculations. Be assured that any time a business owner spends tracking data and ensuring its accuracy is never wasted time.
LTV Data Collection and Calculators
Fortunately, there are plenty of apps available to help you make data collection as painless as possible. A quick web search will yield them. If yours is an online business, then data collection is built into your website. Right?
LTV calculators can be found online, and some sites include downloadable Excel templates. Having an up-to-date Excel spreadsheet full of all of your customers’ data is an invaluable tool.
The Last Word on LTV
In time, you’ll be spinning LTV calculations for the different products or services you offer to identify your most and least lucrative revenue streams. Even if all you do is the most basic LTV calculation, you’ll have an edge on many other small business owners who don’t bother with it at all.
If your business is new, start collecting the data you’ll need for LTV the moment your website goes live or the moment you open the doors. In the meantime, you might be able to find some revenue and marketing and advertising cost estimates for similar businesses online.
- Closer's Cafe: Customer Lifetime Value: How to Calculate It For Low LTV Industries and Why It Matters
- Forbes: Customer Lifetime Value – The Only Metric that Matters
- Forbes: Don't Spend 5 Times More Attracting New Customers, Nurture The Existing Ones
- Practical Insights: Calculate Customer Lifetime Value (CLV) For Small Service Businesses
- smile.io: The Easy Way to Calculate Customer Lifetime Value
- Stitch: Calculate Your Customer Lifetime Value
- clv-calculator.com: Home
- ChartMogul: Customer Lifetime Value (LTV)
LeDona Withaar has over 20 years’ experience as a securities industry professional and finance manager. She was an auditor for the National Association of Securities Dealers, a compliance manager for UNX, Inc. and a securities compliance specialist at Capital Group. She has an MBA from Simmons College in Boston, Massachusetts and a BA from Mills College in Oakland, California. She has done volunteer work in corporate development for nonprofit organizations such as the Boston Symphony Orchestra. She currently owns and operates her own small business. In addition to writing for PocketSense, she writes for Bizfluent, Budgeting the Nest, Legal Beagle, PocketSense and Zacks.