With all the focus on acquiring new customers, it can sometimes be easy to overlook the value and importance of your current customers. However, for any company that depends on a recurring revenue stream or repeat sales, determining the lifetime value of a customer is one of your most important metrics. Calculating lifetime value (LTV) and comparing it to the cost of acquiring a new customer provides valuable insights about how to allocate your sales and marketing budget to increase ROI.
What is Lifetime Value of a Customer?
LTV is an estimate of the amount of revenue you can expect from a customer from the time of acquisition until the termination, for whatever reason, of your relationship with that customer.
How to Calculate the Lifetime Value of a Customer
In its most basic form, calculating LTV is a matter of subtracting the cost of acquiring and servicing customers from the revenue you earn from that customer. Here’s an example of how to determine the lifetime value of a customer:
- Start with how much your typical customer spends on each purchase or the average amount of a sale.
- Determine your net profit on an average sale by subtracting the cost of goods sold or services provided from the sales price.
- Estimate the average lifespan of your customer. How long does a typical customer do business with you?
- Determine the typical number of repeat sales or the typical duration of recurring revenue.
- Consider the value of referrals. How many prospects does your typical customer refer to you over the duration of their relationship with you, and what is the value of those referral sales?
- Determine your churn rate. This is the number of customers you will lose — and therefore need to replace — during a specific period of time.
Why does this matter?
Understanding LTV is important for making decisions about allocation of resources for marketing, sales, customer retention, and other activities. LTV can help you build more accurate customer personas and spend advertising dollars wisely to get the best ROI. It also helps you create brand loyalty.
Improve Your Lifetime Value of a Customer
There are a number of ways to improve LTV. Here are a few tips:
- Develop a loyalty program to encourage more sales.
- Offer free shipping or payment plans.
- Ensure that products are competitively priced.
- Offer product bundles.
- Build relationships by connecting and engaging with customers — for example, through social media.
- Make it easy for customers to reorder or come back to your business.
Acquiring new customers is important, but understanding the value of your existing customers is critical to properly allocating marketing and sales resources. Once you’ve determined LTV, you can focus on ways to improve it to grow profits and expand your business.