Do you know the lifetime value of your customer? No? Let’s change that. Customer Lifetime Value is one of the most useful marketing, and really overall business metrics. However, when I talk to most startups and small businesses they have no clue what their customer lifetime value is.
Customer Lifetime Value (CLV or CLTV) A.K.A. lifetime customer value (LCV), or simply life-time value (LTV) is a metric to understand the entire value of the relationship with a customer. In other words, how profitable is each customer to your business. Once you have a grasp on LTV, you’ll be able to determine your Lifetime Value for Marketing (LTVM). LTVM allows you to set your marketing budget based on your desired growth. Any customer acquisition that costs less than your LTVM is a profitable customer. LTVM allows you to know which marketing tactics and campaigns are really worth your time, barely worth your time, or those campaigns that are actually a complete waste of time resulting in losses instead of profits.
The math for LTV is pretty straightforward, we’re talking basic algebra here. To start we need to know the following: average customer revenue per visit or per order, number of orders per year, how long a customer remains a customer, operating margin, and marketing expense. To make this easier to follow, we’re going to apply some letters to each of these data points:
r = average customer revenue per visit/order
n = number of orders per year
t = length of time in years that a customer is a customer
o = operating margin (in percent)
m = operating margin without marketing expense
operating margin = operating profit/net sales
To calculate LTV, we apply the variables to this equation LTV = t * r * n * o
AN EXAMPLE
One of my clients owns a gym. He charges a monthly membership of $100. His members remain members for 18 months on average. He operates at a profit margin of 40%. So…
r = his average revenue per order is $100
n = the average orders per year are 12 (since members pay monthly)
t = the length of time in years that a customer remains a customer is 1.5 years (18 months in years)
o = profit margin is 40%
Run these data points and the gym’s LTV for a customer = 1.5 * 100 * 12 * .40 = $720
LIFETIME VALUE FOR MARKETING – A NEW METRIC
Now that we know LTV, we take it one step further to get the Lifetime Value for Marketing. Add back in your marketing expense when calculating the operating margin.
m = (operating profit + marketing expense)/net sales
Then LTVM = t * r * n * m
For the gym, they don’t spend a lot on marketing, so their operating margin without marketing is 45%, making their LTV = 1.5*100*12*.45 = $810
Now we know that the gym can spend up to $810 to acquire a customer and still be profitable. If the gym wants to make 20% profit on each customer, then we can take 80% of the LTVM to get what the gym can acquire a customer for and still be profitable. This results in a target LTVM of $648.
HOW TO USE LTVM TO SET YOUR MARKETING BUDGET
If you want to grow your business by 10% this year by adding 10% more customers, you can use LTVM to set your marketing budget. Take the number of current customers and multiply that by 10%. Take the result and multiply it by your LTVM. That’s how much you can spend to breakeven on acquiring those new customers. Want a better profit margin for the new customers? Simply lower your LTVM by your desired profit margin!
GOOD DATA IS KEY
Maybe you don’t have great customer data to make the LTV calculations. Now’s the time to start collecting data, it’s so worth the effort. If you’re an online business, start tracking purchases with accounts or email addresses. If you’re a retail shop, put into place that rewards program you’ve been thinking about to track customer purchases. If you use a POS, whether online or brick and mortar, see if your system has the ability to track purchase amounts by credit card data. Acquiring good customer data allows you to accurately calculate LTV, LTVM, and your marketing budget for growth.
IN RECAP
Lifetime Value is hugely valuable for understanding how each customer adds to your company’s profitability. Additionally, Lifetime Value for Marketing is an insanely valuable tool in setting your marketing budget and hitting your profit goals. Take the time to get your calculations right and always error on the conservative side if you don’t have perfect customer data and you need to make some assumptions.
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