Understanding Customer Lifetime Value (LTV) in eCommerce
In the fast-paced world of eCommerce, understanding the true value of your customers is critical to optimizing your marketing budgets and driving sustainable growth.
In this blog, we'll delve deep into the concept of customer lifetime value (LTV). We will explain how to calculate customer lifetime value and discuss practical strategies to increase customer lifetime value, ultimately maximizing your business's profitability.
What is Customer Lifetime Value (LTV)?
Customer lifetime value (LTV) is the total value of a customer to your business over the entire duration of your relationship. Rather than focusing on individual transactions, LTV encompasses all past and potential transactions within the customer's relationship span with the business. This helps to calculate the specific revenue from that customer. Understanding how to calculate customer lifetime value and utilizing the customer lifetime value formula is crucial for eCommerce businesses aiming to maximize profitability and growth.
The different schools of thought behind calculating LTV
LTV has many interpretations and definitions—because different businesses operate under different contexts. Based on that, they each require distinct insights and approaches to perform accurate measurement. These diverse methods address different business needs and provide tailored insights for optimizing customer relationships and maximizing profitability.
Ultimately, we can split it into 2 main categories: LTV for subscription brands and LTV for non-subscription brands. This is important because it affects how we calculate and look at your customer data.
Subscription brands
A subscription brand or business model is a recurring revenue model in which customers pay a weekly, monthly, or yearly fee in exchange for your products or services. Customers can renew their subscription after a certain period of time. This allows you to leverage your customer relationships to create a steady stream of income.
Historic Customer Lifetime Value
Historic customer lifetime value is the first type that we’ll cover for subscription brands. It’s a retrospective measure that looks back at past transactions to determine a customer's value and makes it useful for understanding the customer’s contributions. From there, the numbers can be extrapolated to make a prediction about the future.
For example, if a customer bought a $100 gift basket annually for the past 5 years, their historic customer lifetime value is $500.
|
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
Historic LTV |
|
|
Example: $100 gift basket annually |
$100 |
$100 |
$100 |
$100 |
$100 |
$500 |
This straightforward measure helps understand what an existing customer has contributed to your brand and build profiles of ideal customers. However, it is less useful for predicting future revenue when considered alone, as it relies solely on historical data without accounting for future potential.
Predictive Customer Lifetime Value
Predictive LTV uses algorithms to forecast future behaviors and revenues based on historical data, catering to businesses focused on long-term strategic planning.
Predictive customer lifetime value leverages historical data to forecast the future value of a customer. This approach considers various factors such as customer acquisition costs, average purchase frequency, and business overheads to provide a realistic prediction of future revenue. It leverages algorithms and machine learning to analyze past behaviors and make educated guesses about future behaviors.
Though complex, this method can guide investments in customer loyalty by highlighting when and where to allocate resources to increase customer lifetime value. Predictive LTV is especially useful for developing long-term strategies and anticipating changes in customer behavior, allowing businesses to stay ahead of the curve.
Non-subscription brands
Cumulative Customer Lifetime Value
Cumulative LTV provides a purely factual perspective by summing actual transactions, making it versatile (and applicable) for both subscription and non-subscription models.
Cumulative LTV focuses purely on transactions that have already occurred, without making projections. For example, if a customer spent $100 two months ago, $80 last month, and $120 today, their cumulative LTV is $300.
This method offers a factual perspective, and unlike the earlier 2 methods it can be used by both subscription and non-subscription brands. It relies solely on actual data and provides clear insights into how your channels perform and if they justify business costs.
Unlike historic and predictive LTV, cumulative LTV does not assume any future transactions, making it a grounded measure of a customer's LTV based solely on their past interactions with your business.
At Fairing, we subscribe (pun intended) to this school of thought. The primary reason is because it caters to both types of brands and can hence be used by a larger audience. Projections make sense only for subscription brands because they have data like the average lifetimes. On the contrary, non-subscription brands would not have such (accurate) information about their customers. As a result, the LTV numbers would be highly inaccurate.
In this method, we are talking actual tangible conversions rather than projections. Combining that with Fairing’s zero-party data from your consumers, we believe that this provides your business highly accurate and precise LTV data about your customers. We find this to be a more intricate approach that would allow your business to have greater clarity into your data.
LTV numbers are usually taken and compared against your customer acquisition cost (CAC) numbers to derive insights. With our accurate LTV calculations, businesses have greater certainty in establishing the timeline it takes to exceed their CAC. As compared to the other methods, they provide you with predictions for the future that may or may not hold true.
Why use LTV vs. other business metrics
Customer lifetime value (LTV) stands apart from metrics like Net Promoter Score (NPS), Customer Satisfaction (CSAT), Customer Acquisition Cost (CAC), and Churn Rate because it is directly linked to revenue.
- NPS measures customer loyalty and their likelihood to recommend your brand, providing insight into potential word-of-mouth growth.
- CSAT gauges how satisfied customers are with specific interactions or products, indicating short-term contentment.
- CAC assesses the cost of acquiring a new customer, essential for understanding the efficiency of your marketing spend.
- Churn Rate tracks the percentage of customers who stop using your product or service over a given period, highlighting retention challenges.
However, these metrics are somewhat intangible and do not directly translate to financial outcomes. Customer lifetime value provides a concrete understanding of the financial contribution of loyal customers. Or in the case of predictive LTV, an understanding of their likely future contribution based on past data.
Tracking customer lifetime value helps businesses develop targeted strategies to acquire new customers and retain existing ones while maintaining profit margins. By integrating LTV with other metrics, businesses can gain a comprehensive view of customer behavior and profitability, enabling more informed decision-making and resource allocation.
The importance of LTV for your business
Save on finances
Calculating and accounting for customer lifetime value (LTV) helps businesses save money by enabling more efficient allocation of marketing spend and customer retention resources. By understanding which customers generate the most revenue over time, businesses can focus their efforts on acquiring and nurturing these high-value segments.
As such, you can reduce spending on less profitable or one-time customers. This targeted approach minimizes wasted marketing spend, lowers customer acquisition costs, and enhances overall profitability through strategic investment in customer relationships that promise the highest returns.
Secondly, retaining existing customers is crucial because it is less expensive than acquiring new ones. Research indicates that customer acquisition costs in eCommerce have skyrocketed by 222% over the past 8 years. By concentrating on increasing customer lifetime value, businesses can achieve growth more cost-effectively.
This involves identifying the factors that foster customer loyalty and replicating those actions. Rather than heavily investing in attracting new customers, businesses can focus on enhancing the experience of their current customers, thereby boosting their overall LTV and ensuring sustainable growth.
Spot and stop attrition
Monitoring LTV can help identify early signs of attrition. For example, if LTV is dropping due to customers not renewing subscriptions, you might improve your loyalty program or enhance customer support around renewal times.
This proactive approach can increase customer lifetime value and overall business revenue. By regularly analyzing LTV data, businesses can detect patterns that indicate potential churn and take corrective measures before it's too late. This could involve offering special incentives to at-risk customers, improving product features, or enhancing customer service.
Find and replicate your best customers
Analyzing high-LTV customers allows you to identify common traits and behaviors. By understanding what drives these customers to repeatedly buy from your brand, you can create a buyer persona and target new customers with similar characteristics.
For instance, if high-LTV customers share common demographics, interests, or purchasing behaviors, you can tailor your marketing strategies to attract similar prospects. Additionally, by understanding the preferences and needs of these high-value customers, you can refine your product offerings and customer service to better meet their expectations.
Use cases: How much are your customers costing you?
Is it wise to acquire these customers?
LTV should be considered alongside customer acquisition cost (CAC). Let’s say you’re running an apparel store on Shopify. You have been marketing your brand aggressively on various platforms and you want to figure out if it’s been worthwhile.
You recently found out that your TikTok customer LTV is $1,200 but the CAC is also $1,200. Your online search LTV on the other hand is $1,000 but the CAC is only $800. With these few numbers in mind, your business might not be profitable unless it reduces acquisition costs for TikTok or invests more in online search.
Balancing LTV with CAC ensures profitable customer acquisition strategies. This analysis helps businesses determine the optimal level of spending on customer acquisition efforts and ensures that the investments made in acquiring new customers are justified by the long-term value they bring.
Cost to serve
This is more pertinent to subscription brands, but understanding the cost to serve each customer is essential. This includes logistics, overheads, and contact center costs. Analyzing these costs can reveal if high-LTV customers are more or less expensive to serve compared to others.
Over time, tracking these costs alongside customer LTV offers a comprehensive view of profitability. Cost to serve may vary across the customer lifetime, unlike customer acquisition which is a one-off expense.
To use a paid TV subscription as an example, your cost to serve might be higher in the first year of a contract but gradually drop off the longer the customer stays with you. Thus, if your renewal rates drop, your average cost to serve is likely to rise and cause a drop in profitability. Understanding these numbers over time and being able to track them side by side is the only way to get a true understanding not only of what’s driving customer spend and loyalty but also what it’s delivering back to the business’s bottom line.
Components of Customer Lifetime Value
Subscription brands
To calculate customer LTV here, three key components are generally considered:
- Revenue Per Customer/Average purchase value: This involves assessing the total income generated from a customer over the entire relationship period, including all transactions. For example, if a customer spends $10 every month for a year, their annual revenue contribution would be $120. This figure is crucial for understanding the direct financial impact of each customer on your business.
- Average purchase frequency: This is the number of times a customer makes a purchase from your brand over the course of your relationship. This is typically broken down into annual frequency.
- Costs: These include all expenses directly or indirectly related to providing value to the customer. This can encompass marketing expenses, cost of goods sold, customer service costs, and any other operational costs associated with maintaining the customer relationship. Accurately tracking these costs helps businesses understand the profitability of each customer segment.
- Customer Lifespan: This is the expected time span over which a customer engages with a company and buys its products or uses its services. For instance, if a customer typically remains active with your brand for three years, this duration is factored into the LTV calculation. The longer the customer lifetime duration, the higher the potential LTV.
Additionally, when considering future revenues and costs, the technique of discounted present value is often applied to account for the time value of money. This involves using an interest rate to bring future cash flows back to their present value, ensuring that the LTV calculation reflects the true worth of future revenue in today’s terms. This approach provides a more accurate picture of a customer's value by considering the changing value of money over time.
Non-subscription brands
For cumulative customer LTV, calculations are a lot simpler.
The sole and primary component is the total spend by the customer across all transactions, since no projections are done. Tools like Fairing’s LTV Analytics can segment and view the LTV of various channels, providing clear insights into their performance and business impact. By using such tools, businesses can easily track and analyze customer spending patterns, enabling more informed decision-making.
Tips on improving your business’ LTV
Customer LTV is all about forming a lasting positive connection with your customers. We have a few ways to boost your LTV figures and nurture those customer relationships.
Invest in customer experience
Every interaction between a customer and your brand contributes to their overall experience. Implementing a customer experience management program helps monitor, listen, and make changes that improve customer satisfaction and loyalty, ultimately increasing customer lifetime value. This can involve regular customer feedback surveys, mystery shopping programs, and continuous training for frontline staff to ensure they provide exceptional service.
Ensure a seamless onboarding process
Optimizing the onboarding process for ease and minimal effort can set the tone for a long-term positive relationship. Personalization and clear communication of the value you provide are crucial during this phase. For example, sending a welcome email series that educates customers on how to use your products or services effectively can enhance their initial experience and increase the likelihood of repeat purchases.
Start a loyalty program
Loyalty programs encourage repeat business by offering rewards. When planned and executed well, they can significantly boost customer lifetime value. A successful loyalty program can take various forms, such as a points-based system, tiered rewards, or exclusive member benefits. Regularly analyzing the performance of your loyalty program and making adjustments based on customer feedback can ensure it remains appealing and effective.
Recognize and reward your best customers
Identify your highest-LTV customers and nurture these relationships with targeted marketing and special offers. Recognizing their loyalty with exclusive perks can further increase their lifetime value. For instance, offering early access to new products, personalized discounts, or VIP events can make these customers feel valued and appreciated, enhancing their loyalty.
Provide omni-channel support
Offering support across multiple channels ensures customers can reach you through their preferred methods, improving their overall experience and satisfaction. Research your customer base to determine their preferred channels and ensure your support team is well-trained to handle inquiries across these platforms. Providing seamless and efficient support, whether through phone, email, live chat, or social media, can significantly enhance customer satisfaction and loyalty.
Leverage the power of social media
Social media is a vital tool for customer communication and brand perception. Timely and empathetic responses to queries or issues on social media can positively influence customer opinions and boost LTV. Monitoring social media for brand mentions and engaging with customers proactively can also help identify potential issues before they escalate, allowing you to address concerns promptly and maintain a positive brand image.
Close the loop with unhappy customers
Proactively reaching out to dissatisfied customers and addressing their concerns can turn them into loyal advocates. This closed-loop feedback system strengthens customer relationships and enhances LTV. By demonstrating that you value their feedback and are committed to resolving their issues, you can rebuild trust and loyalty, leading to a higher likelihood of repeat business.
How Fairing does it
At Fairing, our LTV analytics tool empowers eCommerce merchants to accurately measure and maximize customer lifetime value. By integrating advanced data analytics and machine learning, our tool provides comprehensive insights into customer behavior, helping you make data-driven decisions to enhance customer retention and profitability.
Our user-friendly interface and actionable reports make it easy to track LTV across different customer segments and marketing channels, allowing you to fine-tune your strategies for optimal results.
Interested to learn more about Fairing or LTV? Book a demo here today.
