Customer Behavior

Customer Lifetime Value

Introduction

Optimizing Customer Lifetime Value is one of the best ways to increase your revenue and overall profitability. By definition, Customer Lifetime Value (CLTV) is “the total amount of money a customer is expected to spend on your products during their lifetime” (thanks, Shopify!). More specifically, we like to look at CLTV as the tool to best identify your most important consumer segments. While the metric seems simple on the surface, it gives valuable insights into areas of future growth and improvement. We'll take you through how to calculate this metric, how to understand it in the context of your industry, and how to apply it to the platforms you're using now.

traditional customer lifetime value equation = yearly profit margin per customer * [yearly retention rate / (1 + the discount rate - the yearly retention rate)]

How to Calculate Customer Lifetime Value

There are various ways to calculate LTV (here’s 5 right off the bat!). We’ll be going over two popular methods, what we’ve denoted as: traditional and simplified. First, you can calculate LTV by multiplying yearly profit margin per customer by yearly retention rate, divided by 1 plus the discount rate minus the yearly retention rate. This is the traditional method. The components of LTV can be derived from various time-periods (i.e. day, week, month, year) as long as they’re converted to year units in your calculations (i.e. you can multiple weekly profit margin per customer by 52 to get your yearly profit margin.) If you’re confused about how to define yearly profit margin per customer, yearly retention rate, and the discount rate, we’ve included some nifty explanations below:

  • Yearly profit margin per customer is your profit margin (revenue minus expenses) divided by total number of customers for the year. This helps estimate how much you make on an average customer per year.
  • Yearly retention rate is the number of customers at the end of year minus the number of customers acquired throughout the year, all divided by the number of customers at the beginning of the year. Check out Hubspot’s guide on customer retention for more information.
  • Discount rate is the interest rate, used to bring your LTV to present value.

simplified customer lifetime value equation = average customer lifespan * average amount spent per visit * average number of visits per year

You can also calculate LTV by taking the product of average customer lifespan, average amount spent per visit, and average number of visits per year. Once again, components of LTV can be derived from various time-periods as long as they’re converted to year units in your calculations. If you’re confused about how to define average customer lifespan, average amount spent per visit, and average number of visits per year, we’ve included some nifty explanations below:

  • Average customer lifespan is the amount of time, on average, between a customer’s first and final order. Often times, it is difficult to get an exact value for this, especially if your company is just starting out. We recommend to use 1-3 years, as per Shopify’s eCommerce averages.
  • Average amount spent per visit is how much, on average, a customer spends per purchase. Find this by taking your total revenue divided by total number of purchases for a given year. 
  • Average number of visits per year is how much, on average, a customer visits your shop per year. Find this by taking your total number of purchases divided by total amount of customers for a given year.

When choosing what to include in your calculations, remember: consistency is key! That means, if you use the traditional method to calculate LTV based on this year’s numbers, you should probably use the traditional method for future updates to the figure. Having consistent metrics will allow you to better identify the causes of good or bad performance. For instance, if, over the past few months, you’ve increased benefits for your loyalty programs and LTV also increases, then you’ll know that loyalty program was effective in improving purchase frequency.

Connecting Customer Lifetime Value to Your Business

While you can find components of your LTV from many channels, we’ve identified popular platforms that are particularly relevant to LTV. These may be good places to begin if you’re getting started with this metric:

  • Stripe: If this platform handles your company’s billing and subscription information, you’ll have easy access to the data needed to calculate LTV. For instance, you can plug your numbers into the equations above, or you can use Stripe’s (even more) simplified equation by taking your average revenue per subscriber (ARPS) and dividing by subscriber churn rate.
  • Shopify: Similarly, if you own a Shopify storefront, numbers to calculate LTV are readily-available in your Reports section. For instance, your average amount spent per visit (in other words, average order value) can be found under Sales by Month, and your average number of visits per year can be found under Sales by Customer. Check out Shopify’s guide on LTV for more information.

Tracking Customer Lifetime Value with Lido

While LTV is easy to calculate, it’s important to keep in mind that LTV is one of many valuable metrics to track your performance. If you don’t want to spend hours at the end of the month juggling numbers from your Zendesk and other platforms, consider trying Lido. Lido can help you build a dashboard to monitor your data and give a look into how your key metrics (such as LTV) change over time. With that, we invite you to check out our integrations for the following platform below:

Stripe
Shopify

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