How do you determine whether your small local business is a success? Looking at sales and other metrics over months, seasons, or even a couple of years isn’t necessarily a prediction of whether your business is viable in the long run.
Consider the elements that affect sales and performance at a temporary level—from seasonality to the COVID-19 pandemic and the 2021-2023 multi-factor supply chain crisis. Your numbers can spike in response to these and other external factors.
So, how do you look beyond short-term metrics to understand the soundness of your business? According to many business leaders, customer lifetime value (LTV) is the most important factor—making it critical to learn how to calculate LTV using the customer lifetime value formula.
What is customer lifetime value (LTV)?
Customer lifetime value, or LTV, measures the total spend of your average customer over the span of time they engage with your business—from their first to their last purchase.
It’s a vital component to understanding:
- Your ability to retain customers over time
- Customer satisfaction
- How much, how many times, and how often the average customer spends with you
- Whether you’re over- or under-spending to acquire and retain customers
Ultimately, customer LTV plays a key role in strategic planning for both customer-facing and internal functions. Consider: where do you need to invest to improve your ability to build a loyal customer base?
Why is calculating LTV important?
The customer acquisition cost for acquiring a new customer is 5-7 times more expensive than retaining an existing customer. This means you need to know everything you can to track and increase current customer spending, as well as measure and learn how to increase customer lifetime value.
Tracking LTV can help leaders understand the importance of investing in:
- Customer service excellence
- Efforts to maintain a high customer retention rate
- Segmented, data-driven marketing
- Loyalty programs and levels
Although benchmarks across industries and business models differ, 82% of companies agree that the customer acquisition cost exceeds the customer retention cost. Learn more about this by calculating your LTV:CAC ratio.
Methods for calculating customer lifetime value
We’ve touched on the why, so let’s get into how to calculate LTV. At its most basic, you can multiply the average order value (AOV) by the number of transactions made over the average customer’s lifespan.
If you can’t easily identify your average customer lifespan, then here’s how to calculate customer lifetime value at an annual level that allows you to specifically control the lifespan as its own variable:
LTV = AOV x Average number of orders per year x Average customer lifespan in years
If you need to back up to figure out AOV and other basic variables, then this series of steps shows you how to calculate LTV:
AOV = Total revenue over a period ÷ Number of orders during same period
Order frequency = Number of orders over a period ÷ Number of customers during same period
Customer value = AOV x Order frequency
Customer lifespan = Average customer lifespan in years ÷ Number of customers
Customer lifetime value = Customer value x Customer lifespan
Different models for LTV calculation
Once you learn how to calculate LTV, you can apply it to different models to analyze your data most accurately.
- Historical model – Use past actual data to review performance to date. This is particularly helpful for businesses with limited customer lifetimes.
- Predictive model – Predictive modeling uses your historical data to predict future LTV, projecting forward as much as needed. You can also integrate anticipated change factors (inflation, planned business changes, industry averages, etc.). Machine learning is often used in predictive modeling.
- Cohort analysis – Cohorts typically refer to a group of customers who were acquired during the same month, with the option for additional segmentation by demographics or buying behavior. This level of LTV calculation helps businesses analyze how their changes in process, service, or offerings affect LTV.
Common mistakes to avoid when calculating LTV
Calculating LTV is a complex process. To ensure you’re getting an accurate result, you must have the right customer data. Additionally, LTV can easily be miscalculated by:
- Overestimating customer lifespan
- Ignoring customer churn rate or attrition
- Not segmenting customers properly
Take the next step to understand and connect with your customers
Learning how to track and calculate CLV can help you make informed decisions rooted in understanding your customers. You’ll need to implement strategic business and marketing strategies to measure, track, and boost your customer lifetime value—but, at its core, LTV reflects the basic practices that help you build loyal, long-term customer relationships:
- Fostering connections through quality content and community engagement
- Providing solutions your customers need
- Offering excellent customer service
It’s these same principles that underline:
- Why San Jose real estate agent David Giambruno provides expert insights and hosts events using Nextdoor’s hyperlocal neighborhood connectivity
- How former U.S. Navy Seal Bryan Hall leveraged Nextdoor recommendations to build an in-demand Portland business
- Why Los Angeles real estate agent Clinton Brown chose Nextdoor to bring his trusted customer base and strong neighborhood knowledge and reputation online
If you want to see similar success, plug your local small business into your community through Nextdoor—the top platform for neighbors looking to post recommendations, share experiences about preferred local companies, and discover new-to-them local businesses.
You can quickly set up a Nextdoor Business Page, connect with neighbors using business posts, and increase your profile views through recommendations from members. Then, using the comprehensive Nextdoor Ads Manager dashboard, you can set up Nextdoor ad campaigns with pinpointed targeting and special offers that you can easily track and analyze.
Sources:
- Forbes. Customer Retention Versus Customer Acquisition. https://www.forbes.com/sites/forbesbusinesscouncil/2022/12/12/customer-retention-versus-customer-acquisition/
- SmallBizGenius. 40 Amazing Customer Loyalty Statistics in 2024. https://www.smallbizgenius.net/by-the-numbers/customer-loyalty-statistics/
