Lifetime Value (LTV)
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Ever calculated how much your customers are truly worth to your business? Lifetime Value (LTV) gives an estimate of the average amount that your customer would generate throughout their lifetime.
LTV can help you make informed decisions about resource allocation and customer-focused strategies based on long-term revenue expectations.
A McKinsey & Company study revealed that businesses with strong customer-centric cultures have 60% higher Lifetime Value (LTV), highlighting the link between emotional connections and profitability.
What is LTV (Lifetime Value)?
LTV, or Lifetime Value, refers to the estimated total revenue a customer generates throughout their relationship with a business.
It is a prediction of how much money your customer is worth to your company over their lifetime.
LTV helps you to know the value of each customer so that you can focus on retaining high-valued customers by providing them with optimized services and better customer support.
It gives an approximate calculation of the revenue expected from a customer during their engagement with your business.
The lifetime value of your customer plays an important role while making various financial decisions such as the allocation of marketing funds, resource management, profitability and making future predictions.
It’s one of the key metrics that should be considered especially for the subscription-based business model along with the MRR (Monthly Recurring Revenue).
How to calculate LTV?
There are different ways to calculate LTV. Let’s discuss.
For B2B Companies
B2B industries can calculate their LTV using two methods.
Subscription model
Formula:
| Lifetime Value (LTV) = Monthly average value / Churn Rate |
This is a very simple method to calculate your customer’s lifetime value.
For example, if you have a monthly average value of $1000 for your cold email software tool and a churn rate of 5%, then your LTV would be
LTV = (1000 / 0.05) = $20,000
This would indicate your customer’s expected lifetime would be 20 months.
Non-subscription model
Formula:
| Lifetime Value (LTV) = Average Order Value x Total expected purchases x Time of engagement |
This formula for calculating LTV is ideal when you calculate the total expected income from your new customers, including any add-ons or upsells.
For B2C Companies
Simple Average Purchase
Formula:
| Lifetime Value (LTV) = Average Customer Value x Average Customer Lifespan |
This formula is ideal for businesses with consistent purchase patterns and relatively stable customer lifespans.
For example, for a clothing store, let’s say the average purchase value of a customer is $50 and the average customer lifespan is 3 years.
LTV = 50 x 3 = $150
This formula is easy to calculate and understand.
Discounted Cash Flow
Formula
| Lifetime Value (LTV) = (Average monthly revenue per customer x Gross margin) / (Churn rate + discount rate) |
Discounted Cash Flow (DCF) considers that money you get in the future is worth less than the same amount today. So, it adjusts the value of future money to show how much it’s worth right now.
For example, you have an OTT subscription with $30 monthly revenue per customer. Let’s say you have a 70% gross margin, 5% churn rate and 10% discount rate.
LTV = (30 x 0.7) / (0.05 +0.1) = 140
So the LTV is $140.
Purchase Frequency and Repurchase Rate
Formula
| Lifetime Value (LTV) = Average purchase value x purchase frequency x average customer lifespan |
This formula is ideal for repeat purchases. Businesses with frequent transactions can find this helpful.
For example, you have an online grocery store with an average purchase value of $80 and a purchase frequency of 6 times per year with an average customer lifespan of 5 years. Then your LTV would be
LTV = 80 x 6 x 5 =2400
So your LTV is $2400.
What factors influence LTV?
There are several factors that influence the Lifetime Value (LTV) of your customers, impacting both how much they spend and how long they remain with your business.
Product Pricing
When considering pricing strategies for your products, it’s important to note that higher-priced items typically yield greater long-term value (LTV) than lower-cost alternatives, provided your products deliver substantial value and benefits.
Contract duration
Additionally, the duration of your contracts significantly impacts recurring revenue predictability and subsequently increases LTV. The longer contracts surpass the shorter ones.
Upselling and cross-selling
Investing upfront in building strong customer relationships not only opens doors for upselling extra functionalities but also enables cross-selling complementary products. This strategy ultimately increases your LTV.
Targeted marketing
Focusing on reaching the right customers through targeted marketing not only lowers the cost of acquiring new customers but also increases your LTV.
Referrals
Referral programs can help bring in valuable customers while keeping costs down. It often results in pre-qualified leads that in return lead to high-value, long-term customers.
Customer behavior and engagement
The way your product is used affects its value in the long run. When your customers regularly use it’s features and stay engaged, it shows that your product is giving them value and satisfaction.
When the customers feel satisfied, they tend to buy again and recommend your product to others as well. This helps in increasing your LTV.
So, building strong relationships and providing good customer service is quite important. This will help you with customer retention. You should try to minimize the churn rate as it directly affects your LTV.
Product quality and service factors
You should give importance to your product quality and reliability. It will help in building trust among your customers and would encourage them for long-term usage, thus increasing your LTV.
You should provide excellent customer support that would give a positive experience and reinforce customer loyalty, increasing LTV.
Product improvement
Continuous product improvement can demonstrate long-term commitment. When your team is continuously working towards it’s improvement, then it potentially extends customer lifespan and increases LTV.
Industry and market dynamics
When your product stands out in this competitive market with a unique value proposition, it will attract and retain valuable customers.
As market changes take place rapidly, you should be able to adapt to the market trends and proactively address your customer’s needs. This will ensure your product remains relevant and valuable for your customers.
Customer acquisition
The cost of acquiring a customer affects your profitability. Ideally, LTV should be much higher than customer acquisition cost to justify acquisition efforts.
Also, customers acquired through different channels (e.g., organic search, paid ads) may have different LTVs depending on their intent and value perception.
Customer retention
Retaining your customers is critical for LTV. Long-term customers tend to spend more over time. Building strong relationships, providing excellent customer service, and addressing issues promptly can increase your customer retention rates.
Why is LTV important?
Understanding your customers’ Lifetime Value (LTV) is crucial for your business growth and success. Here are some key reasons why LTV is so important:
Customer Acquisition
Lifetime value helps you with strategic decision-making to determine if your customer acquisition costs are sustainable. It also provides information on which channels provide the most valuable customers.
LTV will guide you on how much you can invest to acquire a customer based on the expected return over the customer’s lifetime.
Resource allocation
When you know the lifetime value of your customer, it will help you allocate your resources more efficiently.
You can accordingly allocate your marketing, sales and support resources to high-value customer segments for maximum return on investment.
Product development
From your LTV, you would get insights into your customers’ behavior and needs. These insights would help you make better product development and service improvements.
In return, this helps retain customers and attract new ones with similar characteristics.
Pricing strategy
LTV considerations can help you optimize pricing strategies to maximize profitability while offering competitive value to customers.
Segmentation
Based on the LTV you can segment your customers (based on value). Segmenting audience would help in enabling targeted marketing campaigns, personalizing your offers and loyalty programs for each segment.
Retention focus
LTV would help to recognise the high value customers, which in return you can use to prioritize your retention efforts and implement strategies to reduce churn rate.
This will reduce the customer acquisition cost and increase profitability.
Customer lifetime journey
With LTV you can analyse your customer behaviour across their lifetime. This will help you understand their purchase patterns. Accordingly you can identify your growth opportunities and predict future engagement.
Forecasting Revenue
LTV can help in forecasting your business’s future revenue. When you get to know the expected value of the customer base, you can project revenue and plan investments and expansions accordingly.
Limitation of LTV
Long-term projections
When you calculate LTV, it often involves making assumptions about your customer’s behavior, retention rates, market conditions, etc. This can be very challenging especially when the market rapidly changes.
Varying customer behavior
Your customer’s behavior can change over time due to various reasons that would be out of your control, like personal circumstances, economic shifts or evolving preferences. Predicting these changes accurately for all your customers can be very difficult.
Complex calculations
Calculating LTV can be complicated and time-consuming because it often involves using complex formulas and analyzing a lot of data. It also depends on your business modal and how it operates. Figuring out LTV accurately might need advanced tools and expertise, which can be quite demanding in terms of resources.
Lack of granularity
LTV calculation might not be able to give you individual customer variation accurately. When you average the value, you might overlook high-value or low-value customer segments within the customer base.
Ignoring non-monetary value
LTV calculation typically focuses on monetary transactions. It does not consider other forms of customer value such as referrals, brand advocacy or engagement that might not directly translate into revenue but hold substantial value for your business.
Tips to Increase LTV
Increasing your customers’ Lifetime Value (LTV) is an excellent way to boost your business’s growth and profitability. Here are some effective tips to achieve that:
Target the right audience
The right audience are likely to stick around and spend more in the long run. You should analyze your high-value customers and use that data to target similar demographics and interests.
Emphasize customer experience
When you prioritize a smooth and positive onboarding process, provide excellent customer service, and resolve issues promptly there is higher likelihood of customer retention.
Optimize acquisition channels
You might be already analyzing which channel brings you the most valuable customers. So along with analyzing, you should also optimize your marketing strategies for those marketing channels.
Personalize communication
One of the most effective ways is to personalize your communication. You can customize your marketing messages and efforts to individual customer preferences and purchase history.
If you are using cold outreach as one of your strategies for customer acquisition then you should try SmartReach.io. It provides a hyper-personalization feature, with the help of Spintax and merge tags making your outreach task much easier and efficient.
Build loyalty programs
You can reward repeat purchases and offer exclusive benefits to high-value customers to encourage their continued engagement.
Upsell and cross-sell strategically
You can recommend relevant products or services based on customers’ purchase history and needs, but avoid being pushy.
Summing Up – Lifetime Value (LTV)
LTV is a powerful metric that helps to get a deeper understanding of your customer base and allows you to make informed decisions that propel your business forward.
Here are some points you should keep in mind.
- Invest in tools and technologies that facilitate accurate LTV calculations and customer segmentation.
- Emphasise a company culture that prioritizes customer satisfaction and loyalty.
- Don’t be afraid to experiment with different strategies for increasing LTV.