What
is an LTV, why is it important?
LTV Formulas- How do you actually calculate LTV
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
