To some, customer lifetime value is an elusive goal that always seems just out of reach. While to others, it’s sacred. For marketers, though, customer lifetime value can be a game changing metric.
What is a customer’s lifetime value, though? And how do you calculate it?
Glad you asked. In the video above, Alex walks you through all the ins and outs of getting started. But we’ll also dig into it here.
What is customer lifetime value (or LTV)?
For those frantically Googling “lifetime value of customer definition,” stop. Your search is over.
Customer lifetime value is the value a customer provides for your business over their entire lifetime. It is the accumulated revenue from the customer’s initial purchase until they stop purchasing/using your goods or services.
While that may sound simple, that calculation can be quite complex, depending on your business model. As Alex points out in the video above, an athletic apparel company like Nike or Adidas may have customer lifecycles as short as a single purchase or as long as a person’s entire lifetime (due to regular, continuous purchases).
Within those literal customer lifetimes, purchases could be frequent, rare, regular, or sporadic.
As you might imagine, it can get pretty complex. So let’s maybe use a different example.
Customer lifetime value in a B2B context
In the video, Alex uses Funnel as an example. We’re a software-as-a-service (SaaS) business that uses a simple subscription-based pricing model.
When customers sign up for Funnel, they start their journey as customers. They pay in regular installments. We then use those regular payments to calculate how much value that customer has contributed to our financial performance.
Why is LTV so important?
Customer lifetime value can inform tons of different business decisions. It can tell you how much your customer acquisition cost should be. For instance, you wouldn’t spend $10,000 on marketing efforts to bring a customer in if they only spent $7,500 throughout their lifetime as a customer.
Additionally, LTV can guide sales on customer support teams. If average LTV across a given tier of customer is especially high, those teams should be acutely aware of any risks to customers leaving or churning.
You can also use lifetime value to guide where to place your marketing and messaging investments. Imagine an initial customer purchase was $100, but their LTV was $10,000. You might be able to infer that they like your product and want to keep making purchases. In this case, running broad marketing campaigns to get customers in the door may be worth it, and then focus your spending on customer retention efforts.
Or, in the same scenario, you may want to use all of your marketing spend to get customers into your ecosystem if your product add-ons and services sell themselves.
How do you calculate customer lifetime value?
The most simplistic lifetime value calculator does this: Revenue per customer x time spent as a customer.
Now, depending on the business you’re marketing, those two main values (revenue per customer and time) could be calculated differently. Plus, as we discussed above, the implications of LTV calculation will differ wildly.
An e-commerce business may take all transactions from each customer and then average them out.
A SaaS company may calculate LTV differently, though.
What about LTV for SaaS?
Let’s imagine that a customer stays onboard for an average of 3 years, paying $100 yearly. That means a rough LTV of $300.
However, we haven’t calculated any add-ons. That $100 / year fee may be the lowest tier of plans available. Over the 3 years, that customer grows to the middle tier. To factor in these dynamics, you’ll likely need to understand how often customers on the lowest tier upgrade and when they upgrade (i.e., in year two or three).
Plus, some customers on the highest tier may opt to downgrade their service over time. Or, maybe the middle-tier customers will upgrade in year two, realize the top level is too much for them, and then downgrade back to the middle tier in year three.
To understand these customer dynamics, you’ll need a pretty robust first-party data gathering system. You’ll need sales and customer success to be working cohesively. And depending on how powerful that data collection system is, you may be calculating assumptions. After all, every customer is unique.
Customer lifetime value can be an incredibly powerful tool. It can steer your organization in a whole host of directions. But with that power comes great responsibility. It’s tough to calculate lifetime value with 100 percent certainty. Depending on your business model, it may not have to be.
A good LTV can be an effective barometer for your business success that, when taken with a grain of salt, can provide a macro view of your effectiveness across marketing, sales and customer success.
Be sure to check out the video above to watch Alex dig into customer lifetime value. Also, you can check out this super interesting article about how comparing lifetime value to customer acquisition cost can deliver even greater insights.