How Should Your Company Consider Customer Lifetime Value?
What is the value of acquiring one customer? Many marketing campaigns carefully consider this cost. They total up all the advertising and free perks offered before the customer commits to a paid product. However, once the customer commits, how much is that relationship worth? The customer lifetime value is the sum of all the customer’s purchases over the entirety of the relationship with the company. It can be the total over years.
While it may seem difficult to compute this value, it’s an important metric for evaluating the effectiveness of a marketing campaign. The lifetime value of a customer can influence how much companies decide to spend acquiring a customer. The value shows whether the acquisition cost was worthwhile. The customer lifetime value (or customer LTV) can be used to determine a good marketing campaign budget that balances lifetime value and acquisition cost.
The Customer Lifetime Value Formula
There are many ways to calculate customer lifetime value. Models range from the complexity of predictive analytics to a simple formula using average values. A formula that relies on averages is shown here.
(Average Value of a Sale) x (The Number of Repeated Transactions per year) x (Length of Relationship in Years)
The lifetime value calculation gives you the revenue from each customer as an average. To get to this number, use the total value of sales over the total number of sales as the average value. The number of repeated transactions per year can be estimated. In the case of a subscription service, this number is simple. A monthly subscription service would be repeated 12 times a year. To calculate a less regular interval, averages are useful. The number of transactions divided by the number of customers over a year will provide a close estimate. Finally, the value of the customer is multiplied by the years in the relationship. This simple customer lifetime value model will give a good estimate of a customer’s value to the company.
Starbucks Customer Lifetime Value
Calculating customer lifetime value can seem abstract until it is applied to a real business. Kissmetrics shows three ways to calculate the lifetime customer value of Starbucks customers. The ‘custom’ customer LTV is most similar to the one described in the previous section. To start, five Starbucks customer purchases are averaged into a $5.90 sale value. Then the customer’s number of visits per week is averaged to be 4.2. To convert this number into years, Kissmetrics multiplies by 52 (the number of weeks in a year). The final variable is the average customer lifespan, which is 20 years for Starbucks.
The Starbucks example also takes into consideration the profit margin. Many customer lifetime value calculations only look at the total revenue. However, the Starbucks example multiplies the value by the profit margin to get a better idea of the profit to the company per customer. The number at the end is smaller but possibly more useful. To further refine the customer value, companies can also subtract the cost of acquiring the customer in the first place. These Go to the full article.