What is customer lifetime value and why does it matter so much to your success? Customer lifetime value is the amount of sales and profits that you earn from a customer during the period in which they continue to order from you or use your services. Lifetime means the amount of time that you are either measuring or the total span from when a customer places their first order until their final order. Lifetime Value is often abbreviated as LTV by marketers. It is a calculation that can transform your business from moving away from struggling to break even into a profit machine. Is it worth figuring it out? Only if you like making a lot more profit.
Once you determine the value of a customer over their lifetime, you can determine what you are willing to pay for new customers and how much effort and resources you should put towards keeping the old ones. The easiest way to determine the customer LTV is to take the number of new customers acquired over a given year, say 2005, and do some math. First you need to determine the number of customers who placed a first time order during the year and let’s assume that the number is 1,000. Now let’s determine how many orders that these new customers placed over time. Let’s say we pick a 5 year period for our evaluation. During the 5 year period we determine that from the 1,000 new customers we received 5,000 more orders with an average order of $200 each. We now know the “average” customer orders 5 times after their first order in a 5 year period and spends $1,000 in addition to their original purchase.
While that part is simple, you need to remember that many of the first time buyers only ordered the first time, and only a percentage of the first time buyers ordered multiple times. That information is where the gold is located. There is an old saying about paying for only the marketing that works. This is a way to get closer to that saying. Look at your buyers that order more than once. These are the customers with a higher life time value. Look at how much they spent on their first orders, what they purchased, what type of businesses they are, etc. All this information will enable you to create a marketing plan that will maximize profits by targeting the customers that are most likely to order more than once. A first time buyer is a “tryer” a second time buyer is a customer.
For our example, let’s assume we discover that the first time buyers that are males who are over 40 and live in the southern area of the United States, re-order 80% of the time, we now have a prospect pool to fish in. You can then tailor your marketing efforts to get a higher first time response and you also can fine tune your after buy programs to push for your best buyers to come back again. In business we make our profits from our existing customers and we constantly hunt for new customers. It is important to have different marketing plans for both. Response rates from existing customers are much higher than prospects. This creates a favorable marketing spend level to existing customers and this is where profits are made. New customers are an investment. There are many ways to use the customer lifetime value calculation and data to your advantage. By diving into your data you can unlock all the secrets to the treasure chest that is your business.