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.
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:
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?
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:
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.
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
Once you learn how to calculate LTV, you can apply it to different models to analyze your data most accurately.
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:
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:
It’s these same principles that underline:
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