If you’re a business owner, there’s a good chance you’ve heard of the term “LTV” before, as it’s a crucial metric that can have a significant impact on your bottom line. Improving your retention rate could increase your LTV, which is a good thing. But what exactly is LTV, and how do you calculate it?
To calculate your LTV, multiply the average number of purchases you receive from a customer by the average lifetime value of that one purchase. For example, a customer pays you a monthly fee of $10. If that customer stays around for 6 months, the total LTV for that customer would be $60 ($10 x 6).
In this article, I’ll explain everything you need to know about LTV so that you can tell the difference between customer value and customer lifetime value. Let’s get started!
LTV is a crucial revenue metric
As a crucial revenue metric, Lifetime Value (LTV) estimates your net profit for the entire association you have with a customer. Explained another way, it’s the total revenue you’re likely to receive from a customer during your dealings with them.
LTV is important because it allows you to see the big picture regarding your customers. It’s not enough to simply acquire new customers. You need to keep them around for as long as possible so that they continue generating revenue for your business, which is where LTV comes in.
By learning what a particular customer’s LTV is, you can determine how much you should spend on retaining that customer.
How do you calculate LTV?
Now that we’ve answered the question “what is lifetime value?” let’s look at how to calculate it. The formula for calculating LTV is relatively simple:
Lifetime Value = (Average order value x Average purchase frequency) / Average customer churn rate
Let’s break down each element of this formula so that we can understand it better:
- Average order value: This refers to how much each customer spends per order on average. You can calculate it by dividing the total revenue over a specific period by the number of orders placed.
- Average purchase frequency: This is how many orders a customer will place with you over a given period. To calculate it, take the total number of orders during this period and divide it by how many unique customers also purchase in the same timeframe.
- Average customer churn rate: This is the percentage of customers who stop doing business with you over time. You can determine the average churn rate by dividing the number of customers who stopped doing business with you over a specified period by the total number of active customers at the beginning of that timeframe.
For example, let’s say you have a customer who spends $100 monthly over 2 years. Your average churn rate is 10%.
You can use the above formula to determine your customer lifetime value as follows:
(100 x 12 x 2) / 10 = 2400/10 = $240
Based on this calculation, you can see that this customer will generate an average of $240 in revenue for your business throughout their relationship with you.
What is the difference between customer value and customer lifetime value?
The terms customer value and customer lifetime value can be a bit confusing, as there is some overlap between the two.
Customer value is the estimated net profit attributed to a single purchase from a customer. Customer lifetime value assumes that customers will likely make multiple purchases from your company over time.
In other words, customer value is the revenue from a single transaction. On the other hand, customer lifetime value is the revenue from the entire association with a customer. As you can see, LTV is the more valuable metric because it provides a broader view of your customers’ worth.
As you can see, LTV is a critical metric for any business owner to understand. By calculating your customers’ LTV, you can make informed decisions about where to allocate your resources to maximize profits.
Do you need help calculating your LTV? Use our free LTV calculator to simplify the process. And remember, don’t be afraid to experiment with different tactics to boost your LTV even further!