You\u2019ve heard of Customer Lifetime Value (LTV). You know that it\u2019s important and that companies who can increase overall LTV can significantly increase their bottom line.<\/p>\n\n\n\n
You\u2019ve probably even heard the stats<\/a>, like that the top 1 percent of ecommerce customers are worth a whopping 18 times more than the average customer. You know that approximately 80 percent of your future revenue<\/a> will come from 20 percent of your most loyal customers, and that increasing customer retention rates<\/a> by 5 percent can result in an astonishing 25-95 percent increase in revenue.<\/p>\n\n\n\n You\u2019ve also heard that LTV is critical for calculating metrics such as desirable customer acquisition cost; but how does one calculate Customer Lifetime Value?.<\/p>\n\n\n\n In this post, we\u2019re going to break down:<\/p>\n\n\n\n By the time we\u2019re done, you\u2019ll be able to attend ecommerce cocktail parties (or perhaps even conferences) and sound like a seasoned vet as you discuss LTV.<\/p>\n\n\n\n On the surface, LTV is a rather simple concept. Like the name says, it\u2019s how much an average customer will spend with your business over the lifetime as a customer. <\/p>\n\n\n\n It\u2019s the average cumulative total<\/strong> of all of their purchases for the duration of time that they\u2019re purchasing from you.<\/p>\n\n\n\n Let\u2019s say you have two customers named Eric and Erin. <\/p>\n\n\n\n Eric always wants to shop around to find the best deal. He\u2019s not particularly loyal to any one brand, and is willing to purchase from just about anyone as long as he feels like he\u2019s getting a good deal. Price matters more than relationship to him. Eric occasionally purchases from your site, but only when you\u2019re offering the lowest price on a particular product. <\/p>\n\n\n\n Erin, on the other hand, likes to find brands she loves and then stick with them for the long haul. You happen to be Erin\u2019s favorite ecommerce store for purchasing household goods, and she buys almost everything from you. <\/p>\n\n\n\n Out of the two, who will have the higher lifetime value as a customer? Obviously, it\u2019s Erin. But, and this is critical, your average LTV is not based on Erin alone. It\u2019s based on the average cumulative total of all the purchases of all your customers, including loyalists like Erin and those who shop around, like Eric. <\/p>\n\n\n\n This starts to get to the heart of why this metric matters so much. If you have fifty customers like Eric and four customers like Erin, your LTV is going to be low, which then negatively affects a host of other aspects of your business. Let\u2019s break this down a little more.<\/p>\n\n\n\n LTV is far more important than most ecommerce store owners realize. Here\u2019s why:<\/p>\n\n\n\n Generally speaking, your Customer Lifetime Value should be at least three times greater than your Customer Acquisition Cost (CAC). <\/p>\n\n\n\n In other words, if you\u2019re spending $100 on marketing to acquire a new customer, that customer should have an LTV of at least $300. If it\u2019s not somewhere in that 3:1 ballpark, your profit margin won\u2019t be high enough to scale your business. <\/p>\n\n\n\n Remember, your LTV has to essentially cover all the expenses associated with each customer. This includes marketing, shipping, customer service, the specific technology you employ, and much more. <\/p>\n\n\n\n Without a 3:1 LTV to CAC ratio, scaling is going to be really difficult. You\u2019ll be operating with razor thin margins and constantly have to be fighting for new customers, which is always a precarious position. One down month can throw off your entire business.<\/p>\n\n\n\n If you have a low LTV, it means you either need a new customer retention strategy or need to significantly revamp your existing one. <\/p>\n\n\n\n If your retention strategy isn\u2019t effective, it means you must constantly acquire new customers to maintain revenue. Your ad spend is going to be much higher and your ROI on that ad spend will be low. If there ever was a lose-lose situation, this is it. Additionally, without loyal customers, you become vulnerable to ups and downs in the market. <\/p>\n\n\n\n When the economy takes a downturn, customers who aren\u2019t loyal to your brand will go to the seller with the lowest price.<\/p>\n\n\n\n There\u2019s a relatively simple way to determine how well your marketing efforts are working: compare your Customer Lifetime Value to your Customer Acquisition Cost. The lower the ratio, the lower the ROI you\u2019re getting on your marketing efforts. <\/p>\n\n\n\n For example, if you have to spend $200 to acquire a customer, and your LTV is $200, your marketing efforts are almost a complete wash. You\u2019re not really adding anything to your bottom line, and you\u2019re setting yourself up to eventually run out of money. <\/p>\n\n\n\n No one can operate at a 0% profit margin for long (unless you\u2019re independently wealthy and running your store for kicks, in which case you probably can stop reading now). As Kevin Donnelly notes<\/a>:<\/p>\n\n\n\n “Customer Lifetime Value (CLV) is one of the most important factors in determining your business\u2019 present and future success. It\u2019s an often-overlooked metric that can accurately predict how much your customers are really worth. By measuring the net profit that you\u2019ll take in over the course of your entire relationship with a customer, you\u2019ll be able to narrow down exactly how valuable they are to your business.”<\/p>\n<\/blockquote>\n\n\n\n\n
What Is Customer Lifetime Value?<\/h2>\n\n\n\n
Why Is Customer Lifetime Value So Important To eCommerce?<\/h2>\n\n\n\n
LTV Determines Whether You Can Scale<\/h3>\n\n\n\n
LTV Helps You Evaluate Your Retention Strategy<\/h3>\n\n\n\n
LTV Allows You To Determine The ROI Of Your Marketing Efforts<\/h3>\n\n\n\n
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