Customer lifetime value (CLTV) is one of the most important metrics to measure at any growing company. By measuring CLTV in relation to cost of customer acquisition (CAC), companies can measure how long it takes to recoup the investment required to earn a new customer — such as the cost of sales and marketing.
Simply put, LTV measures the projected revenue from a customer over the lifetime of their relationship with your business. Knowing the value of the repeat business helps you determine how much you should invest in customer retention and acquisition. Lifetime value is also referred to as customer lifetime value (CLV) or lifetime customer value (LCV).
Projecting the lifetime value of a customer provides business owners with important insights for decisions about:
- Product development: LTV metrics factor into decisions on how to incorporate customer feedback into product development. For example, you can decide whether it is cost effective to make major product changes to satisfy the demands of a small segment of the custom er base.
- Marketing: Knowing the LTV of a customer can help determine whether acquiring new customers provides a sufficient return on investment (ROI). The marketing strategy is ineffective if the marketing costs to acquire a new customer exceed the LTV.
- Customer Support: Increasing customer satisfaction is statistically one of the best ways to retain your most valuable customers and increase LTV. According to the Harvard Business Review, it is five to 25 times more expensive to acquire a new customer than it is to keep a current one.1
How Is Customer Lifetime Value Calculated?
In the simplest form, LTV equals Lifetime Customer Revenue minus Lifetime Customer Costs.
Using a simple example, if a customer purchases $1,000 worth of products or services from your business over the lifetime of your relationship, and the total cost of sales and service to the customer is $500, then the LTV is $500.
Armed with this information, spending anything in excess of $500 on marketing to acquire a new customer would be a negative return on investment. Businesses typically earmark 10% of LTV ($50 in this case) on acquisition costs. However, startups or struggling businesses will often sacrifice profit margins on acquisition to build the customer base and improve cash flow. Netflix, for example, kept its prices low for years in order to expand its subscriber base, and it has continually grown revenues by around 30% per year.23
In the real world, the distribution of customer purchasing behavior is highly variable. As illustrated in the following example chart, some customers may be one-time or occasional buyers, while others are regular purchasers who have a higher LTV and generate the most profits.
We can therefore refine the LTV calculation using an average of the customer distribution. In the above chart example, the sum of the LTV for all customers would be:
(10 x $500) + (20 x $1,000) + (100 x $1,500) + (20 x $2,000) + (10 x $2,500) = $240,000
Dividing by the total number of customers gives us an average LTV:
Average LTV: $240,000 / 160 = $1,500