Lifetime Value (LTV), also known as Customer Lifetime Value (CLV), is a metric used to estimate the total revenue or profit a business can expect from a single customer over the duration of their relationship with the company.
It helps businesses understand the value of acquiring and retaining customers and informs decisions about marketing, customer service, and product development.
How to Calculate Lifetime Value:
There are several approaches to calculating LTV, ranging from simple to complex, depending on the available data and business model. Here is a basic formula:
Simple LTV Formula:
LTV
=
Average Purchase Value
×
Number of Purchases per Year
×
Average Customer Lifespan (years)
LTV=Average Purchase Value×Number of Purchases per Year×Average Customer Lifespan (years)
Where:
Average Purchase Value = Total revenue / Number of purchases
Number of Purchases per Year = Total purchases per customer in one year
Average Customer Lifespan = The number of years a customer typically remains loyal
Example:
If a customer spends $50 per purchase, buys 4 times per year, and remains a customer for 3 years:
LTV
=
50
×
4
×
3
=
$
600
LTV=50×4×3=$600
More Complex LTV Formula (including profit margin and retention rate):
LTV
=
(
Average Purchase Value
×
Purchase Frequency
Churn Rate
)
×
Profit Margin
LTV=(
Churn Rate
Average Purchase Value×Purchase Frequency
)×Profit Margin
Where:
Churn Rate = The percentage of customers who stop buying over a period
Profit Margin = Percentage of revenue kept after costs
Why LTV Matters:
Customer Acquisition Costs (CAC): Helps businesses determine how much they should spend to acquire a customer.
Retention Strategy: Indicates how much effort and investment should go into customer retention.
Resource Allocation: Informs decisions on marketing spend, product enhancements, and customer service efforts.
By optimizing LTV, businesses can maximize profits, focusing on acquiring and retaining valuable customers.
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