Do you know how much a single customer is worth to your business?
In this article, you’ll discover a way to find your customer lifetime value (LTV) and learn how LTV can inform your marketing efforts.
How establishing customer lifetime value (LTV) improves marketing decisions?
Your customer LTV is how much the average customer is worth to your business in the lifetime of their relationship with you. Lifetime, in this context, refers to the number of years you retain that customer. For example, your average customer might do business with you for 6 years and purchase 3,000 Euros of products or services during that time.
Different audience niches often have different LTVs. Some customers will stick around longer, while others may regularly make purchases that have higher-than-average order values.
Only by understanding your LTV can you accurately assess the long-term ROI of your campaigns. It’s also a crucial figure that you’ll want to take into account when determining how much you can afford to spend to acquire a customer through digital marketing.
Businesses that have tight profit margins or typically see a higher customer acquisition cost may be able to spend more to acquire individual customers once they factor LTV into the equation instead of only the profit of the first sale.
Let’s say you pay 10 Euros per customer on Facebook ads and your average profit margin per order is 11 Euros. At first glance, it doesn’t appear to leave a lot of room for revenue or growth.
However, when you factor in LTV, you may realize that your average customer will purchase 10 times on average, giving you 110 Euros in sales for a 10 Euros customer acquisition cost. That’s a substantially larger ROI and may have you rethinking your Facebook and Instagram ads budget and any bidding minimums you have in place.
How to calculate customer LTV?
Start by calculating your average purchase value, which is the average euro amount of each purchase. To find this, divide total revenue in a set time by the total number of purchases in that same period.
Total revenue / Number of purchases = Average purchase value
Next, calculate the average purchase frequency rate, which tells you how often individual customers purchase from your business on average. To find this value, divide the number of purchases in a set period by the number of unique customers who purchased in that same period.
Total number of purchases / Number of unique customers who made a purchase = Average purchase frequency rate
Now calculate your customer value. This tells you how much the average customer is worth to your business at any given point. You can find it by multiplying the average purchase value by the average purchase frequency rate.
Average purchase value x Average purchase frequency rate = Customer value
You also need to know the average customer lifespan, which tells you the average of how long customers actively purchase from your business. This is simply the mean of all of the years that customers purchase from you, which is information you can get from your CRM or sales platform. The last step is to calculate your average customer LTV. To find this value, multiply the average customer value by customer lifespan.
Average customer value x Customer lifespan = LTV
What is considered a good LTV?
What’s considered a “good” LTV can be subjective so benchmarks listed online aren’t always the most reliable. Factors like industry, business age, and business model can all result in wide fluctuations for the baseline LTV metric.
This is why it’s so important to shoot for a target LTV based on your business’s other metrics and existing performance. To assess whether your current customers have a solid LTV, you first need to know your customer acquisition cost (CAC).
Ideally, you want a 3:1 ratio in terms of LTV to your CAC. In other words, you want to make at least 3 Euros in gross profit (or have a 3 Euros contribution margin) for every Euro you spend acquiring that customer.
If you’re making under 3 Euro in gross profit per 1 Euro in ad spend, this can become expensive or unsustainable over time and prevent you from scaling. In this case, it may be advisable to either spend less on digital marketing or find a way to increase LTV.
If you find that you’re above the 3:1 ratio, you may want to consider investing more in new customer growth. This will help you continue to expand your customer base, potentially reach new audiences, and grow your business.