Customer Lifetime Value – How to Calculate it.

Posted March 4, 2014 in

One of the best ways I come up with content ideas for this blog is to answer questions our clients and employees have for me. Today I got just one of those great questions about Lifetime Value. A client was asked what their Custome Lifetime Value is. They didn’t know. It’s simply a huge issue for them. Most likely because, well Tristan Handy at RJMetrics said it best last September: “We’ve found that calculating customer lifetime value is one of the single biggest challenges digital marketers face. Companies tell us that they spend countless hours with SQL queries and spreadsheets or pay thousands of dollars to consultants.” Is it really that difficult to determine?

Well first, you need to know why it’s important. Tristan also hit this nail right on the head: “Knowing your CLV is the key to effective marketing. If you know your customer lifetime value and your cost to acquire a customer, you know whether you have a profitable, scalable business or not. Segment these same numbers by customer acquisition source, channel, and ad placement, and you have a recipe for optimizing your marketing.

We’ve also wrote a lot about why Lifetime Value is important to understand what you are doing and if that is working or not: “It allows you to value the customers from one marketing channel vs. another and gives you much needed insight into where to focus your marketing and sales budgets. The higher Customer Lifetime Value channel should get more budget, engagement and resources.

So, after reading that, you know it’s important and whether or not you know your CLTV or not, you probably should figure that out. But how do you determine what your Customer Lifetime Value is?

Let’s see what others have to say:

Ted Ammon, Ecommerce Inbound Marketing Specialist, thinks it’s pretty simple: (Average Order Value) x (Number of Repeat Sales) x (Average Retention Time). He has a great article on the subject at Hubspot. Read more here.

Jeremy Lew of Lightspeed Venture Partners has this to say: “Lifetime Value is calculated as the cumulative contribution of an average customer, so you have to multiply lifetime revenue by contribution margin. Contribution margin should include all variable costs except one time acquisition costs. This typically includes COGS, packaging, shipping and handling, reverse logistics, inventory obsolescence/write offs, customer service, credit card charges, hosting costs, fraud accruals etc. It would not include fixed costs such as photography, production, site development, merchandising or other overhead.” Read more here.

Here is an awesome infograph on calculating lifetime value by using Starbucks as an example. “Roughly defined, LTV is the projected revenue that a customer will generate during their lifetime.” Check this out for great info on “average customer lifespan”, “customer retention rate”, “Avg. Gross Margin per customer lifespan” and more. Seriously fantastic infograph.

RJMetrics on Inside Ecommerce has another great Customer Lifetime Value Article. They even have an amazing Customer Lifetime Value Calculator!

Now, what do we think?

The math is pretty simple, it’s the assumptions built into it that are not cut and dry. So here are some notes:

1. No two companies determine Lifetime Value the same as the other. There isn’t one definition. Like the examples above, some consider retention rate, some remove costs to calculate the margin contribution and some don’t. You have to determine your own set of rules.

2. What is a lifetime? Almost every client we work with that tracks Lifetime Value has a different definition of how long a lifetime is. Some are straightforward – a lifetime is an actual lifetime and the revenue and margin contribution should reflect every single order an average customer purchases through you for their entire life, from cradle to grave. Others consider the lifetime to be the actual lifetime of their average product. They sell kayaks, you don’t buy one of those every 6 months, but more closer to every ten years. Their lifetime isn’t 10 years, but it isn’t indefinite. Still another client of ours knows that if their customer doesn’t purchase in two years, they are gone and never come back. So their lifetime is 2 years. You should have a really good idea of how your customers behave to help you determine the length of time of a “lifetime”.

3. Total Revenue or Margin Contribution? This really gets to the intent of why you want to know CLTV. In the end I like the idea of identifying the margin contribution of each average order so you can then multiply it by the average number of orders for an average customer. Similar to what Ted said above. Avg Margin per order X Avg # of orders over a lifetime = CLTV.

But wow that is a lot of data to collect – every single customers’ data? Yes, I’d recommend collecting all your customers’ revenue and order data, for the lifetime period you determine, and then average them all out and use one of the equations above. But let’s say you simply don’t have access to or the time to process hundreds of thousands of customers’ data? No problem, why not grab 1000 random customers and use their data?

Collect the data you need for 1000 random customers and plug it into the equations above. Will it be perfect, no. But we aren’t looking for perfection. We are looking for guideposts to help us determine the success of a channel, campaign, source, partner, period, offer etc. Your data will never be perfect, but this will definitely be a start.

 

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About the author

  • Jamie Birch

    Jamie Birch

    Founder/CEO

Jamie is the owner and principal of JEBCommerce. His extensive Internet marketing experience includes all facets of online marketing: email, paid search campaigns, customer retention programs, and much more. This wide range of disciplines has enabled Jamie to excel as a business leader and JEBCommerce to realize a great level of success for its clients. Jamie cut his “affiliate marketing teeth” managing affiliate programs for many well known companies before spending several years at Coldwater Creek, a Top 5 nationwide women’s clothing retailer. While at Coldwater Creek, Jamie established and managed affiliate campaigns, email campaigns, and SEO campaigns – an opportunity that allowed him to develop many of the proven processes JEBCommerce successfully employs today. In recognition of his professional leadership, the affiliate marketing industry has consistently nominated him for Annual Pinnacle Awards over the years. In addition to individual accolades, JEBCommerce is gaining momentum within the Internet marketing industry and is experiencing positive, exciting growth. This is a direct result of Jamie’s positive leadership, integrity, and earned respect – from his clients and industry peers. Need a speaker for your next event? I can do that, too!