How to Calculate LTV

What is LTV?

Put simply, LTV is the net profit each customer contributes to your business over the entire lifetime at your company.

How is LTV calculated?

LTV is the sum of a unique customer’s historic purchase profitability, plus forecast purchase profitability, plus forecast referral profitability, less forecast attrition less marketing cost to acquire and marketing cost to service and then ­finally, adjusted for the cost of money based on how many years each is forecast to remain an active customer.

Seems complicated. Why is customer lifetime value important?

Customer lifetime value may be the most important metrics in your marketing tool belt. We all know that it’s more costly to acquire new prospects than to retain existing ones – thus extending your LTV is central to a healthy business model and customer retention strategy.

Here are ­five reasons why managing LTV as a core metric is vital if you want to increase profitability, retention and overall marketing success.

  1. Generate real ROI on customer acquisition

    LTV helps you focus on the channels that give you the best, most profitable customers. You should be optimizing your marketing channels in terms of the lifetime value a customer contributes to your brand, rather than the gross profit on the initial purchase.

    You are therefore trying to maximize your customer lifetime value in relation to your customer acquisition cost (LTV:CAC). Focusing on LTV will change the economics of your customer acquisition strategy. Suddenly you may be able to pay a lot more to acquire a highly profitable customer because you are not held back by the profit generated from a single purchase, but from the forecast purchases made over a lifetime with your brand.

    Information about your customers with the highest LTV (VIP customers) will also provide you insight into exactly who you should be targeting in terms of demographic.

  2. Enhance your retention marketing strategy

    The value of retention (and anti-attrition) marketing campaigns should not just be valued on the instant revenue they drive. It should be valued in terms of what impact it had on the average LTV of the segment of customers you are targeting. How did it alter the trajectory of LTV over time for an average customer? To calculate this, you’ll need accurate predictive analytics so that you can see how predicted LTV is influenced by different marketing actions.

  3. Create more effective messaging, targeting & nurturing

    Segment your customer base by LTV so that you can improve the relevance of your marketing with more personalized messaging. A useful variable to use here would be the types of products/services you market to your customers from different segments.

  4. Improve your behavioral triggers

    By organizing data into natural groupings (or clusters) you can discover the behavioral triggers that incentivized your best customers to make their first purchase.

    Once you’ve analyzed your best clusters, you should be trying to replicate this behavior with your prospective customers in order to turn them into first-time purchasers and eventual high-LTV customers.

    Similarly, and surprisingly underutilized, is identifying the clusters that are a drag on profitability, decrease resources and costs assigned to them and then study those clusters to make sure that future acquisition efforts don’t target prospects who look and feel similar.

  5. Improve output from customer support

    Focus your time on giving special attention to your most valuable customers. Never forget Pareto’s handy little principle: 20% of your customers generate 80% of your revenue. Using LTV to identify your most valuable customers will help you decide where to direct your customer service resources. Paying attention to your most valuable (and profitable) customers will help you push up margins, at the same time as fostering strong relationships through better service with your most important segment.

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