Calculate and understand your Lifetime Value as easy as 1, 2, 3.
What is Customer Lifetime Value (LTV) and Why is it important?
The customer lifetime value (LTV), is the total estimated revenue a store earns over the lifetime of their relationship with a single customer. LTV gives a single view to your ecommerce data by normalizing the sales journeys to either inform of your success or failure.
By calculating LTV on its own, the metric gives you an outlook on how well a store retains valuable customers, increases revenue from less valuable customers, and surfaces ways to improve the overall customer buying experience. Depending on your products, LTV should inform how much you should spend on customer acquisition, through the metric of Customer Acquisition Cost (CAC).
How can you use CAC with LTV? What benefit would it give you?
LTV will not be able to provide details of whether the store is growing or slowing down unless paired with CAC. If your CAC is higher than your LTV, it suggests you’re losing money for every customer acquired. If your LTV is higher than your CAC, it suggests that you may be achieving a good retention rate when compared to the cost to acquire the customer.
A healthy LTV to CAC ratio is 3:1, this suggests the value of your customers should be three times more than the cost of acquiring them. If the ratio is 1:1, it suggests that you may not be making any profit from your customers as they are only generating as much profit as you’re spending on ad spend to acquire them. A higher ratio of 5:1, suggests you’re spending too little on advertising and may see a reduction in your LTV as buying cycles end for your current cohort.
Customer Acquisition Cost =
How do you calculate Customer Acquisition Cost (CAC)?
First, we need to start by calculating the base metrics:
Advertising Spend is calculated by summing all advertising expenses across all channels in the given timeframe.
Number of Unique Customers is calculated by summing the number of unique customers who placed an order with your store in the given timeframe.
Customer Acquisition Cost is calculated by dividing Advertising Spend by the number of orders, giving you the direct cost attributed to acquiring a single customer.
In Practice
A health supplement store spent $100,000 on advertising last month, and its marketing team reported 10,000 unique customer placed orders. This results in a CAC = 100,000 / 10,000 = $10.
Lifetime Value =
How do you calculate Lifetime Value (LTV)?
First, we need to start by calculating the base metrics:
Average order value (AOV) is calculated by dividing the store’s total revenue over a period of time by the total orders placed by its audience during that same timeframe.
Average order frequency (AOF) is calculated by dividing the total number of purchases made over a period of time by the number of unique customers who ordered during that same timeframe.
Average customer lifespan is the average number of years that a customer continues to order from the store.
Lifetime value is calculated by multiplying the value of the customer (AOV * AOF) by the average customer lifespan, helping a store identify how much revenue they can expect to earn from a single customer over the life of their relationship with the store.
In Practice
The average order value for a health supplement store is $50 and, on average, a customer shops six times every year. The lifetime value for one year is calculated as LTV = $50 x 6 x 1 = $640.
Customer lifetime value can help a store estimate future cash flow and the number of customers it requires to achieve profitability and a positive acquisition cost.
Which Metrics Affect Lifetime Value?
1. Churn rate
The churn rate describes how often customers stop shopping at a business. This directly affects LTV by decreasing the overall value or revenue that could have been earned from the customer. It’s important to ensure you keep your churn rate low and your brand loyalty high.
2. Net Promoter Score
This suggests how loyal customers are to the store, and who continues ordering. Building brand loyalty to acquire a positive Net Promoter Score can help retain customers and decrease overall churn rate, leading to a higher lifetime value.
How to Increase LTV?
1. Act on customer feedback
Open communication between the store and the customer can help a customer relate to the brand better. It is important for stores to listen to feedback from their customers as it can help them improve growth and reduce overall churn rate.
2. Retarget existing customers
An effective way to increase LTV is to re-engage with customers who have previously ordered or are actively ordering from the store. These efforts could include email campaigns, Facebook ad campaigns, or community content releases to new and existing customers.
3. Increase branded community activity
Industry trends are currently suggesting an increase in community activity from store influences can have a very positive impact on LTV. This is accomplished through providing more relatable content, a direct persona that is tied to the store that the customer can interact with, and a better personality for the store.
4. Increase AOV amounts
Depending on your store and the products you sell, an opportunity to increase LTV is to deploy other sales opportunities within your store. An example of this is the creation of product upsells and cross sells as the customer creates a transaction in your store. We can suggest the CartHook Shopify App, one of the easiest product upsell/cross sell apps on the Shopify store.
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Originally published at https://blog.uncoil.ai on January 31, 2020.
