Customer Lifetime Value- CLV or LTV -Basics

What is an LTV, why is it important?

What is LTV?

Customer Lifetime value can be defined as the projected revenue that a customer will generate during their entire lifetime. It is very important for the company to understand this metric as it helps them to shift their small term focus like quarterly profits to long term focus like customer relationships.

Why it is important?

It is a critical metric that tells a company how much Total Net Profit a company can make from any give customer. Apart from this, it also helps companies to-

1.Tell how much you need to spend to acquire new customers/retain old customers

2.How much repeat business company can expect from certain customers

3.How can a company offered products and services customized for their best customers

4.How much should a company spend to service and retain a customer

5.What type of customers you should focus to acquire

6.Align marketing campaigns along with the budgets, finances etc

7.Effective customer segmentation- based on their LTV

8.Customize marketing strategies for future audiences

      9.Allocating and managing budgets efficiently, select right media, channels, platforms etc 

LTV Formulas- How do you actually calculate LTV

3 Major Formulas to calculate LTV- Final result is Average of 3 formulas.

Generally all the 3 methods are used and finally an average is taken to get the LTV.

All 3 formulas gives absolutely different figures

Please note that there are many formulas to calculate LTV and none of them is universally accepted

Example 1 -How to calculate LTV?

Data available (sample- for ref.)

Avg. customer lifespan (t) =4 years  > (Formula is 1/Churn rate)

Customer retention rate (r) - 75% {so the churn rate will be 25%}

Profit Margin (p) – 20%

Discount rate (i) - 10%

Number of weeks per year= 52

Avg. Gross margin per customer lifespan (m)= $14204.32*20% = 2840.86    (20% of the simple LTV output)

Calculations (we will calculate by all 3 methods and then take average)

Simple LTV = 52(a)*t = 52(68.29)*4

                   = $14,204.32

Custom LTV= t(52*s*c*p)

                    = 4(52*9.6*3.94*0.2) = $1573.48

Traditional LTV= m{r/(1+i)-r}

                          =  2840.86{.75/(1 +0.1)-0.75}

                          = $ 6087.56

Average LTV= ($14,204.32 + $1573.48 + $ 6087.56)/3

                     = $7288.44

Example 2 -on how to calculate LTV

Average order value/Revenue:  $20       Frequency (of purchase)- 12 times

Average customer lifetime period- 5 (from the assumptions-in years)

 Profit margin- 70% (from  assumptions on the left)

Retention rate- 80% (from assumptions on the left)

Discount rate - 15% (industry standard for start-ups who have scaled up, got funding and are profitable- as per discount cash flows . Details here)

Formula for CLV = (Revenue x Frequency x Lifetime x profit margin x retention rate)/(1 + discount rate – retention rate)

CLV= (20*12*5*0.7*0.8)/(1+ 0.2-0.8) = $1680