What is Customer Lifetime Value, and Why Does it Matter?
June 2, 2022
Understanding the value of your customers is at the heart of running a successful ecommerce business. Knowing how much customers are likely to buy, and how often, helps you create a sustainable business and informs the types of products you offer in your store. Two key metrics that inform this understanding are lifetime value (LTV), and customer lifetime value. Let’s break down what they are, how to calculate them, and why they matter.
What is lifetime value (LTV)
Lifetime value (sometimes referred to as LTV) is the total amount of revenue your business can expect to earn from one customer over the course of your relationship with that customer.
How to find lifetime value (LTV)
Lifetime value (LTV) can be a complicated metric to calculate, depending on the number of customer touchpoints incorporated into the measure. But, the metric boils down to three inputs that can be multiplied to produce an average lifetime value.
The numbers you need to calculate lifetime value (LTV):
1. Average order value (AOV)
AOV refers to the average amount a customer spends on a purchase with your business. You can calculate this number for your entire customer base by taking an average of all of your order values. To produce a more nuanced AOV number, you could segment your data into different customer segments based on your customer profiles and calculate an average order value for each segment.
2. Average number of transactions per period
This number is the average number of purchases a customer makes in a certain period. For example, the average number of transactions per period for a grocery store may be 1 purchase/week. For a coffee shop, the number might be closer to 3 purchases/week.
3. Average customer retention period
The average customer retention period is the amount of time you’d expect a customer to be a customer of your business. You can find this number by examining the behavior of your customers to see when they make their first purchase and when they make their last purchase with your business.
Calculating lifetime value (LTV)
To calculate lifetime value, multiply all three of your numbers: AOV, average number of transactions per period, and average customer retention period.
Let’s work through an example. If your business has:
AOV = $50
Ave. transactions per period = 1/week
Ave. retention period = 5 years
Then your LTV calculation would look like this:
($50) x (52 purchases per year) x (5 years) = Lifetime Value of $13,000.00
Customer lifetime value (CLV) vs. lifetime value (LTV)
The difference between lifetime value (LTV) and customer lifetime value (CLV) is important and often misunderstood. While lifetime value refers to the average total revenue you receive from a customer, customer lifetime value incorporates your costs (like COGS, marketing spend, and overhead) to determine the total profit you can expect to receive from a customer. This is an important distinction: if you rely only on your LTV number, you can overestimate your contribution margin and build a faulty business model.
How to find customer lifetime value (CLV)
To calculate your customer lifetime value, you must multiply your lifetime value (LTV) number by your expected profit margin.
Let’s work through an example. If your business has:
LTV = $13,000
Margin = 50%
Then your CLV calculation would look like this:
($13,000) x .5 = Customer Lifetime Value of $6500
Why customer lifetime value matters
To run a profitable business, it is absolutely essential to understand how much revenue a customer will bring to your business. Changes to your CLV number can be a sign of growing attrition, smaller margins, or that your tactics to retain customers are working. The customer lifetime value number allows you to make forecasts about your profits, and informs how much you are willing to pay to acquire a customer. The higher your customer lifetime value (CLV), the more room you have to spend on customer acquisition through channels like digital ads, direct mail, and out of home advertising without diminishing your profits.
How Canal can help you boost your customer lifetime value
Improving your customer lifetime value involves increasing your customer loyalty, growing your average order value, and keeping your costs low. Canal can help improve these metrics by helping you easily sell new products that your customers will love. By using Canal’s simple Shopify app to offer a larger variety of products that align with your brand, you can encourage a higher average order value because your customers have more products to choose from when they make a purchase. And, constantly updating your product catalog creates more reasons for your loyal customers to come back again and again. Most importantly, adding products to your store with Canal requires no additional operational spend, meaning you won’t decrease your profit margin. With Canal, you simply earn additional profit on more products without spending on warehousing, product development, or inventory.
Ready to improve your CLV by discovering and partnering with trusted brands in the Canal network? Learn more.
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