Lifetime Value

What is lifetime value?

Also known as customer lifetime value, lifetime value or LTV is the projected total revenue you can gain from a particular customer over the course of your B2C relationship with them.

If you want a more in-depth understanding of this topic, check out the FAQ section below:

Question #1: How do I calculate a customer’s lifetime value?

To calculate, all you have to do is multiply the average size of each of their transactions with your business with the average number of transactions that occur annually. This is expressed by the formula:

Average Transaction Size x Number of Transactions Per Year x Retention Period = CLV

Let us go over it in more detail:

Let us say you run a cafe. If a particular customer orders $20 worth of drinks and food every visit and comes 70 times a year over the course of four years, then their customer lifetime value would be $5,600:

$20 (Average Transaction Size) x 70 (Number of Transactions Per Year) x 4 (Retention Period) = $5,600 (CLV)

This is the exact same formula you would use for practically any kind of business.

If you teach guitar online, for example, all you have to do is multiply your monthly tuition by the average number of months a student stays enrolled. So, if you charge students $30 a month and each student stays enrolled for six months, then a typical student’s customer lifetime value would be $180:

$30 (Average Transaction Size) x 6 (Number of Transactions Per Year) x 1 (Retention Period) = $180 (CLV)

But what if a typical student stays enrolled for three years instead? Well, that would give us an average customer lifetime value of:

$30 (Average Transaction Size) x 12 (Number of Transactions Per Year) x 3 (Retention Period) = $1,080 (CLV)

The same goes for a hotel. If the average guest spends $500 per stay and checks in four times a year for five years, then their customer lifetime value would be $10,000 using the same formula:

$500 (Average Transaction Size) x 4 (Number of Transactions Per Year) x 5 (Retention Period) = $1,080 (CLV)

Question #2: How important is it to know the lifetime value of my customers?

It is extremely important to know the lifetime value of your customers because it helps you:

• Figure out how much you should spend on acquiring new customers
• Perform profit forecasting

Let us go over each one in more detail:

First, by knowing how much money each customer is likely to bring into your business, you can get a pretty good idea of how much money (and time) you should spend on acquiring them.

For example, if an average customer is expected to bring in $8,000 in revenue to your business, then spending $100 to acquire them should not be a problem.

In contrast, if your average is just $300, then you need to spend significantly less money on acquiring them—ideally while trying to increase the amount of revenue each customer brings in.

Second, when you know your average customer lifetime value, you can easily calculate not only how much revenue you are making right now, but, more important, gauge how much more you stand to gain if you manage to get more customers, get each customer to spend more, keep each customer for longer, or accomplish all three.

Question #3: How can I improve each customer’s lifetime value?

Given that the formula for lifetime value is ‘Average Transaction Size x Number of Transactions Per Year x Retention Period’, all it takes to improve each customer’s lifetime value is to increase any one (or all) of these variables.

You can do so by using any of the following techniques:

• Running a rewards/loyalty program
• Running promotions
• Improving your customer service
• Improving your after-sales support
• Offering top-notch products and/or services