Lifetime Value (LTV) measures the total revenue a customer will bring to a business over their entire lifespan as a customer.
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Lifetime Value (LTV) is a critical metric in marketing and sales that represents the total net profit a customer is expected to generate for a business over the entire duration of their relationship. It quantifies the long-term value of a customer to the company and helps businesses understand the long-term value of each customer, making it easier to create effective marketing strategies, optimize pricing, and allocate resources in areas that will generate the greatest return on investment.
LTV takes into account various factors, including the average purchase value, the frequency of purchases, the customer retention rate, and the operational costs associated with serving the customer.
By calculating LTV, businesses can determine how much they can invest in acquiring new customers and retaining existing ones while remaining profitable.
The basic formula for calculating Lifetime Value (LTV) focuses on three primary inputs: Average Revenue Per User (ARPU), Gross Margin, and Churn Rate.
The formula looks like this: ARPU x Gross Margin / Churn
Let’s consider an e-commerce business that sells beauty products online. Over the past year, they collected data on their customer base and want to calculate the LTV to understand the value of their customers over time.
To calculate ARPU, divide the total revenue generated by the number of customers over the given time period, for example: $500,000 in total revenue from 10,000 unique customers.
ARPU = Total Revenue / Number of Customers ARPU = $500,000 / 10,000 = $50
Determine gross margin, by calculating the difference between net sales revenue and the cost of revenue, showing the profit margin of the business. For instance, if net sales revenue is $400,000, and the cost of revenue is $150,000:
Gross Margin = Net Sales Revenue – Cost of Revenue Gross Margin = $400,000 – $150,000 = $250,000
Calculate the churn rate, the percentage of customers who stopped using the product or service during the given period: say it’s 20% during the year.
Churn Rate = 20%
Now, using the inputs we have, we can calculate the LTV for this e-commerce business. LTV = (ARPU x Gross Margin) / Churn Rate LTV = ($50 x $250,000) / 20% LTV = $12,500
In this example, the calculated Lifetime Value (LTV) for the e-commerce business is $12,500. This means that, on average, each customer is expected to generate $12,500 in net profit over their lifetime as a customer.
A good Lifetime Value varies depending on the industry, location, business model, target audience, and other factors.
Generally, a higher LTV is desirable as it indicates that customers bring in more revenue over their lifetime, allowing businesses to recover customer acquisition costs and achieve profitability sooner. A “good” LTV depends on factors such as the average cost of customer acquisition and the company’s profit margins.
Here are some recent benchmarks from US-based companies:
LTV is often considered in relation to Customer Acquisition Cost (CAC). According to some online resources, a 3:1 ratio is considered good.
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Let’s go over some effective strategies to enhance LTV:
More resources to help you improve:
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Customer Lifetime Value (CLV) and Lifetime Value (LTV) are often used interchangeably, but there can be slight variations in their definitions. CLV typically focuses on the individual customer level, while LTV may refer to the aggregate value of all customers as a whole. The underlying concept remains the same, measuring the total value a customer brings to a business over their lifetime.
LTV is a measure of profit, not revenue. It takes into account the cost of acquiring and serving customers, making it a more accurate indicator of a customer’s value to the business.
Yes, CLV can be negative, in cases where the cost of acquiring and serving a customer outweighs the revenue generated from that customer. A negative CLV indicates that the customer relationship is not profitable and may require further analysis and improvement strategies.
Churned Recurring Revenue measures the revenue lost due to customers cancelling their subscriptions or not renewing. It helps track the impact of churn on your business.
Churned Recurring Revenue by Plan ID is a metric that measures the total amount of revenue lost due to customer churn, broken down by the specific subscription plan the customers were on at the time of churn.
New Recurring Revenue measures the total revenue brought in by new subscriptions in a given period, excluding upgrades, downgrades, and churn.
The Upgraded Recurring Revenue metric measures the additional revenue generated by existing customers through upgrades or expansions of their subscription plans.
Customer retention rate is the percentage of customers that return and continue to do business with a company. It is a measure of customer loyalty and satisfaction.
Net New MRR is a metric that measures the total amount of revenue generated from new customers minus the revenue lost from cancellations and downgrades.
Growth Rate is the percentage increase or decrease in revenue over a set time period, used to gauge the performance of a business and its ability to expand.
Percentage of Paying Customers who Churned by Cancelling their Subscription(s) during the specified Date Range.