Customer lifetime value (otherwise known as LTV) is one of the most important metrics to track when it comes to the long-term success and sustainability of your eCommerce business. So let’s explore what it is, why it’s important, and how to improve it.
What is LTV?
LTV is the total amount of revenue a customer is expected to generate for your business over a certain period of time (like 12 months) or throughout their entire relationship with you. Estimating the financial benefit of individual customers over time means you can identify your most valuable customers, manage your marketing budget for a better ROI, and optimise your strategy accordingly. Essentially, it’s all about using your historic customer relationship data to forecast the ongoing value a customer brings.
Is LTV relevant to your business?
Not every eCommerce business should be using LTV as one of their main metrics because for some brands, LTV just isn’t possible. For example, mattress brands are less likely to have LTV because people don’t replace their mattresses very often. Therefore, customers are unlikely to make a repurchase in the near future. Eventually, customers may repurchase years down the line, but ideally you’d want LTV for the first couple of years post-purchase, if not sooner, in order to scale your brand quicker.
If you’re about to start a new eCom business, you need to think about whether your product range has LTV, and if not, it might be best to start with a product range that does allow you to leverage LTV. Otherwise, you could end up just chasing new customer acquisition revenue with no stability of returning customer revenue.
If your eCom business is already up and running but your product range doesn’t really allow for LTV, you could consider developing a second product range of main or ancillary products that allow you to generate LTV.
Why is LTV important for your acquisition and retention strategy?
If your product range does allow for LTV, but LTV isn’t considered a key element in your acquisition and retention strategy, you’re probably focused on making as much profit as possible on first orders and any profit from repeat orders is just the icing on the cake. But by focusing on achieving a higher net profit from order to order, you’re limiting your ability to scale your revenue.
It’s 5x cheaper to retain customers than to acquire new customers. Building your strategy around LTV puts the focus on leveraging your returning customers. By focusing on LTV, you’ll aim for smaller profits or just to break even on first orders, making higher profits from returning customers. The resulting lowered marketing efficiency goal for acquiring new customers allows you to scale your ad spend higher, in turn generating a higher total amount of contribution margin dollars.
For example, if you have a breakeven NCPA (New cost per acquisition) of 2.1 ROAS and spend 31k in ad spend at 5.45 ROAS, you’ll generate 168k in monthly conversion revenue and 48k in contribution margin. However, if you scale ad spend to 201k but lower the ROAS CPA target to 3.94, the monthly conversion revenue would increase to 794k, but more importantly, the contribution margin would grow to 174k.
Key components for LTV
To accurately calculate LTV, you first need to understand these three key components:
- Average Order Value (AOV): The average amount a customer spends per transaction. To calculate the AOV, just divide the total sales revenue from that customer by the number of purchases they’ve completed.
- Purchase Frequency (PF): How often customers make purchases over a specified period. PF is calculated by dividing your total number of orders within a given time by the total number of customers within that time period.
- Customer Lifespan (CL): The average duration a customer remains active with your business, from their first purchase to their last. A longer lifespan usually results in a higher LTV as it indicates prolonged engagement and consistent revenue contribution.
The easiest way to collect this data is through a 3rd party tool like Lifetimely.
How to calculate LTV
LTV can be a more complex metric to understand, thanks to the varying behaviour of customers. But the core formula remains the same:
For example, if your average order value is £40, customers purchase an average of twice a year, and they remain active with your business for five years, the LTV calculation would be:
£40 (AOV) × 2 (PF) × 5 (CL) = £400 (LTV)
This means each customer is expected to bring in £400 over their lifetime with your business.
Another example could be a subscription product like a coffee pod brand. If the subscription was £25 a month and the average subscription lasted three years, the LTV calculation would be:
£25 (AOV) × 12 (PF) × 3 (CL) = £900 (LTV)
For this product, each customer would generate £900 in revenue over the course of their subscription.
LTV:CAC ratio
Once you understand and are able to calculate your LTV, many businesses find it helpful to then calculate their LTV:CAC ratio. This ratio compares the LTV of a customer against the customer acquisition cost (CAC). Your LTV:CAC ratio should at least be 1:1. Anything under this and you’re losing money. But ideally your ratio should be much higher than this. At a minimum, you should be aiming for at least a 3:1 ratio, indicating that for every pound spent acquiring a customer, three pounds are generated in revenue.
Calculating your LTV:CAC ratio will help you identify whether your acquisition costs are too high (if your ratio is low) or if you’re under-investing and missing growth opportunities (if your ratio is really high).
How to use LTV to grow your business
LTV is a valuable tool for optimising various aspects of your business and marketing strategy. By understanding the LTV each customer brings, you can better allocate your marketing budgets and ensure you’re not under or over spending on acquisition. For instance, knowing your LTV allows you to set realistic bid caps for your paid campaigns, ensuring that your CPA remains within profitable limits. It can also help guide your upselling and cross-selling strategies, particularly for high-value customers who are more likely to respond positively to personalised marketing, further increasing your revenue.
Additionally, knowing your LTV helps with your financial forecasting. Knowing what your customer cohort values allows you to predict how much revenue your returning customers will generate month by month over the upcoming months.
How to track and increase your LTV
First order month
One way to track your LTV for your business as a whole is the percentage or monetary value you generate from returning customers on a month by month basis. This allows you to track the average first order value for a cohort of new customers each month and the average revenue per returning customers each month.
The data below comes from an eCom brand who has an average of 73.87% LTV 12 months after the initial purchase and 104.75% after 24 months. This shows that this brand’s LTV increases most within the first year. For example, if the average AOV per new customer is £50, that would mean they will spend on average £15.78 more after 3 months, £36.94 more after 12 months, and £52.38 more after 24 months.
To gather this data, you could use a tool like Lifetimely to export the data. Shopify also allows you to gather and analyse cohort LTV data on their analytics dashboard. Once you’ve gathered this data, you can then use it to fuel your retention strategy. Informing you of the popular months that customers repurchase, allowing you to send the bulk of your customer retention emails within these popular periods. Doing this puts you in front of your customers when it matters most, keeping your business front of mind when customers are ready to buy.
Products and categories
Unlike the first method, which looked at the LTV of your business as a whole from a new customer cohort perspective, this method looks at the LTV of your individual products and/or categories. The benefit of doing this on a product or category scale is that you’ll be able to identify what products and categories are generating the most revenue from both the net first purchase and from month by month LTV.
In the example below, category 5 has the biggest LTV with a 52.46% increase within a year of first purchase. However, it’s important to not just look at the LTV percentage but to also take into account the amount of revenue generated and the number of new customers. Although category 5 has the largest LTV, it’s only 3% higher than category 1’s LTV and yet category 1 has a higher number of new customers compared to category 5 by 1481.45%. In this case, the focus should be on improving the LTV for category 1.
Once you know your best performing products/categories, you can focus your marketing efforts around them. This could be running retention strategies like email marketing or remarketing ads based wholly on the individual product or category with the best LTV.
Just like LTV can be tracked on a month by month basis in Lifetimely and Shopify, product and category LTV can also be tracked in Lifetimely.
Offer Testing
LTV can be analysed by the offer code a customer used when making their first purchase. Tracking the data in Lifetimely, you can test different types of offers and identify which one(s) have the best net first order and the best LTV for different time periods after the initial purchase.
For example, the data below shows that this eCom brand has a higher LTV for their 30% off discount but a higher number of new customers for their 50% off discount. It’s worth noting that all of these discounts were tested on the same products. Therefore, it’s important to also look at the first order value. Comparing the 50% and 30% discounts, 30% off has a 29.53% larger first order value than 50% off. And when we look at the 90 day and 12 month LTV, the 50% discount has only seen an LTV increase of 20.28% at 90 days and a 41.28% increase in 12 months. Whereas the 30% discount had a 49.72% increase in LTV within 90 days and a 104.94% increase in LTV over 12 months.
Additionally, selling at a £50 AOV with 30% off compared to 50% off is a £10 difference, having a big impact on your margins. CPA data also needs to be considered here. For this example, the CPA for 30% off is 50p more expensive than the 50% off. However, even with this slightly higher CPA, the discount margin means the 30% off discount will still create a better contribution margin. Therefore, I would recommend focusing on increasing the number of new customers purchasing using the 30% off discount.
Segmentation
Segmenting your customers within your email retention strategy means you can send more personalised cross sell and upsell product recommendations. This puts the products that your customers are more likely to be interested in in front of them, making them more likely to make a second or third purchase.
For example, a fashion brand could segment by clothing style or size, a beauty or skincare brand could segment by skin type, and a sportswear brand could segment by type of sport.
The example below shows that segmentation could also be organised by the first product the customer bought. This screenshot from Lifetimely shows the customer purchase journey showing us what products customers buy as their second, third, and fourth purchases.
Based on this data, I would segment customers based on the first product they purchased, providing more accurate product recommendations based on what customers tend to order on their next purchase. For example, for customers who bought the Vegan Plant Shake Milk Tea as their first purchase, their cross sell emails would focus on repurchasing the same item, but also recommend the Epic Subscription and the Party Value Pack. Products like the Berry Subscription would not be included as none of the Vegan Plant Shake Milk Tea customers bought that item after making their initial order. Therefore, including the Berry Subscription would waste space and attention in the emails and wouldn’t convert.
Valuable content
Finally, providing valuable content through email marketing and social media can help to keep your customers interested and engaged in your business. It’s important to note that this strategy should only be used if you genuinely have valuable content to share. Genuine valuable content identifies your brand as an authority with expertise in the industry, encouraging trust and loyalty with your customers. On the other hand, sending content that’s not genuine or valuable could be seen as annoying, causing customers to move away from your brand.
The type of valuable content you produce will depend on the type of eCom business you run but may include content like safety guides, motivational content, case studies, and advice on different ways to use your products. For example, a fashion brand could send out style guides with ideas of how to design and accessorise different outfits. Another example could be a gardening brand sending out seasonal flower guides telling customers what to plant and when or guides on how to care for garden furniture throughout the year.
The example below is from a bedding company, providing their customers with valuable content on how best to care for their Egyptian cotton bedding.
Are you ready to take control of the future of your business? I can help you calculate your LTV and optimise your business based on these numbers. Just get in touch.