Thinking about your customers or clients transactionally might be correct of they only ever buy from you once, but in all other situations where repeat purchases happen or are expected, lifetime value (or LTV) is a more accurate measure of what a customer or client is worth to your business. The calculation for LTV is different than just figuring out the costs and profits associated with a transaction, and often, each transaction has different profitability.
What is Lifetime Value?
Lifetime value is a metric to show how valuable a client is during the time they are purchasing things from you. As you can imagine, a customer who comes to a restaurant multiple times is more valuable than someone who only comes once. The incentive to focus on lifetime value in that situation is the understanding that getting a customer to come back for a second or third time is easier and cheaper than finding a second or third customer to try the restaurant once.
If you think about this as loyalty, you’d be on the right track… And loyalty is often rewarded with free products, exclusive incentives, discounts or cashback. Those loyalty programs are designed with LTV in mind, it’s cheaper to give you your 5th coffee for free than to get a new customer in the door.
Often, LTV explains the many “sign-up now” promos where the math simply doesn’t make sense. One of those are cable companies offering a $1000 TV when you sign up for a $49 per month package. Wait… That doesn’t add up–or does it? If the cable company believes that you’ll be a customer for long enough, they’ll cover the cost of the TV and be profiting off your business (more on the math later).
The customer thinks they are getting a sweet deal and the cable company is betting on long-term profitability, although they are hedging their bet with a contract term.
In what situations does LTV apply?
Not all businesses can benefit from using LTV as a metric. Usually, this is because the second transaction is not typical or much too far in the future. For example, the average span between real estate purchases is over 7 years. While there might some who are buying a home more frequently, post-sale marketing is designed to get another transaction through referrals.
LTV is applicable for businesses that offer:
- subscriptions (like Netflix or Amazon Prime)
- on-going services (social media marketing agency or cleaning companies)
- Utilities (internet service provider or electricity)
- retainers (lawyers, advertising agencies)
- Products that run out and you buy again (vitamins or skincare, paper or toner for your printer, gas for your car).
This last category is what is most interesting to us. The other categories above have a distinct business model that requires recurring revenue for the business to function. That last category doesn’t have a standard practice of marketing for the long-term, instead, many marketing campaigns are aimed at new user acquisition. The most expensive way to grow your business IF customers could be buying repeatedly from you.
If you have an online store and you’re not seeing a high number of repeat purchases, let’s talk. We’ve got solutions for that. Your customers should be coming back!
E-commerce is where we see LTV most misunderstood. I’m not sure why this is. New Users are valuable and you certainly shouldn’t turn off that pipeline. However, you’ve got customers already that you’re not pulling back to your store. In fact, there are products that make so much sense not to change that a customer making a decision to buy from you is already thinking that they are going to be purchasing for a year or more. Think about any part of your morning routine, when was the last time you switched something up? In the bathroom – same shampoo, same soap, same toothpaste. You get it, those things are rarely changed unless the person is purely shopping on price.
Well, that’s where it gets interesting.
You can easily increase your LTV by offering discounts so people will continue you buy from you. For example, If it costs you $25 to acquire a new customer, then you’re still ahead with a $24 discount. While this is a drastic tactic, it proves the point that even the thriftiest customers can be loyal – you just need to know what buttons to push.
On a $100 product, that $24 might convert better as “getting the 5th one free” because then you don’t need to discount each transaction and you can count on 4 purchases before opening up the discount discussion again.
If you have an online store, look closely at how your customers divide. How many have only purchased once? How many have purchased more than once?
Here’s your immediate action items in both scenarios:
- For customers who have only purchased once, send them a coupon code immediately for their next purchase, ask them how they liked what they bought-no matter how long ago it was. This gives an incentive to come back.
- For customers who have purchased more than once, send them a coupon code for a product that complements what they have already been buying from you as a thank you and as a recommendation to something you think they’ll like. We’ve seen this have an interesting effect where they buy the product you’re recommending and what they have been already purchasing from you. This creates a personalized shopping experience that increases their value per cart.
While you’re in your customer dashboard looking this up, also take a look at those customers who have bought from you multiple times and see how frequent it is.
Are they coming back each month?
Now, set up a follow-up email reminder for 2 weeks before that time frame (that’ll cover the shipping time to get there before they run out).
Here’s how to calculate LTV.
First, Understand the difference between CAC and LTV:
CAC (Customer Acquisition Cost): Attracting customers isn’t free. Between advertisements, content marketing, and other strategies, businesses sink a lot of funds into gaining new customers. Customer acquisition cost, or CAC, is the cost of gaining each new customer. Read more here.
LTV (Lifetime Value): Life Time Value or LTV is an estimate of the average revenue that a customer will generate throughout their lifespan as a customer. This ‘worth’ of a customer can help determine many economic decisions for a company including marketing budget, resources, profitability and forecasting.
Churn: The rate of customers who stop buying from you (or that you lose, in the case of subscriptions)
It’s easy to understand how they work together, and why they are both independently important. You need to understand what your CAC is, mainly because you cannot always see your LTV. For example, you may expect a customer to stay with you for 5+ years, but since you’ve only been in business for 3 years, with little churn, you cannot say exactly what your LTV is. However, you can use CAC and Churn to make a compelling case that you’re building strong retention and that you’ll be keeping customers happy for years.
Focus on your Lifetime Value, your bottom line will thank you.
This article is actually based on a conversation that we have with many of our clients when we discuss how to increase sales. It is still amazing to us that email isn’t dead, people want to come back to places they have bought at before, and yet stores are not actively bringing people back to buy.
Take the opposite approach and get focused on what happens after the first sale, you’ll be impressed with the results and the work you put in will pay dividends for years to come.
This post was written by Chris Milton, who worked in retail during high school selling sneakers and has been taking that in-store process and applying it to our client’s stores. Old habits die hard-like knowing how to take care of someone coming to your store, no matter if it’s a brick & mortar shop or an online store. Let’s build a great customer experience for your store-traditional or digital.