What is Lifetime Value (LTV)?
Lifetime Value (LTV), also known as Customer Lifetime Value (CLV), is the total revenue a business can expect to generate from a customer over the entire duration of their relationship. It reflects the long-term financial contribution of a customer, factoring in their purchase frequency, average order value, and retention over time.
Why is Lifetime Value important?
LTV is important because it helps businesses understand the long-term profitability of their customers and guides decisions on marketing spend, customer acquisition, and retention efforts. By knowing how much value a customer brings over time, businesses can determine how much they can afford to invest in acquiring and retaining customers while maintaining profitability.
How does Lifetime Value work?
LTV works by calculating the total expected revenue from a customer using this process:
1. Determine Average Purchase Value: Calculate the average revenue generated from a single purchase.
2. Assess Purchase Frequency: Measure how often customers make purchases over a given period (e.g., annually).
3. Calculate Customer Lifespan: Estimate how long, on average, a customer continues doing business with the company.
4. LTV Formula: Multiply average purchase value by purchase frequency, then multiply the result by the average customer lifespan. The formula is:
LTV = Average Purchase Value × Purchase Frequency × Customer Lifespan
For example, if a customer spends $100 per purchase, makes 4 purchases a year, and remains a customer for 5 years, their LTV would be:
LTV = $100 × 4 × 5 = $2,000
Understanding LTV allows businesses to create more targeted acquisition and retention strategies, focusing on high-value customers for sustained growth.
