What is customer lifetime value (LTV)?

What is customer lifetime value (LTV)?

Customer lifetime value predicts the gross profit a customer brings to your business in their lifetime.

The metric refers to a customer’s revenue value over the long term. The longer a customer continues to buy from the company, the higher their lifetime value becomes. 

This measurement can be used by marketing and customer support teams to influence the customer journey. By quickly and objectively identifying the customer segments most valuable to the company, they can target customer engagement and marketing activities accordingly.

How does LTV work?

If a company spends more on bringing in a new customer than that customer pays each year, then more customers would automatically need to be acquired for the marketing investment to be justified. Knowing the LTV means that you can quantify how much revenue is being brought into the business and compare it to how much it costs to acquire those customers. 

It’s simpler and more cost-effective to sell to an existing customer than it is to acquire a new one. This is why it is crucial that existing customers are happy with what your company provides so that you can keep them in the long term, making up for the investment that it took to win their business in the first place. 

LTV is a crucial metric that can help determine which customers are bringing in the most revenue. When calculating the LTV, it is essentially the average amount of money spent by a customer throughout the amount of time that their relationship exists with you. 

If a customer buys $1,000 worth of goods or services every year for three years, their LTV would be ($1,000 x 3) $3,000, minus the cost of acquiring the customer. If $200 was spent on the marketing campaign that led to the customer purchasing for the first time, the LTV is ($3,000 minus $200) $2,800.

There are more layers to measuring LTV that are also taken into account: 

  • Average Order Value (AOV) = Total Sales Revenue / Total Number of Orders
  • Gross Margin (GM) = (Total Sales Revenue – Cost of Goods Sold) / Total Sales Revenue
  • Churn Rate (CR) = (Number of Customers at the end of Period – Number of Customers at Start of Period) / Number of Customers at Start of Period
  • Purchase Frequency (F) = Total Number of Orders / Total Number of Unique Customers

Why is LTV important?

Understanding LTV is essential as it can be a crucial driver of increasing revenue over time. The longer the lifecycle or the greater the value a customer brings during the lifecycle, the more income the business will make. Tracking and improving CLV inevitably results in more significant revenue, as it helps to identify the specific customers bringing the most revenue into the business. 

This, in turn, enables the company to serve those existing customers with products and services that help them, which leads to them spending more money with the company. Taking the time to analyse LTV can also help you to spot issues around customer retention. 

When it comes to growing the business, LTV can help you target your ideal customers. If you have precise data around the amount of money that specific customers or segments bring into your business, you can build a customer acquisition strategy that targets this type of customer.