Calculating Customer Lifetime Value is one of the most powerful ways to understand the loyalty and impact your shoppers hold. Maybe more importantly, it helps you know how much you can spend on marketing while still remaining profitable. Calculating customer lifetime value with Customer Acquisition Costs (CAC) also helps measure overall profitability.
Most softwares and tutorials use rough estimates to calculate LTV. Estimates can be valuable, however serious marketers looking to accurately measure their efforts must focus on calculating LTV at the most detailed level. This will reduce margins of error which can result in costly mistakes & improper marketing decision making.
There are many tools and methods to calculate LTV across your entire store. However, merchants face several major challenges when trying to calculate and analyze LTV.
- LTV is most useful if it can be analyzed on a per marketing channel and campaign basis – getting this data can be very difficult
- By definition, LTV must take Gross Profit & refunds into consideration. Collecting & organizing this data in an accurate manner is a very challenging & tedious task.
- The “lifetime” part of LTV is very difficult to calculate accurately – especially for new stores and new marketing campaigns.
Let’s dig a little deeper into these 3 challenges.
1) Analyzing LTV on a per marketing channel basis
This is important because it allows you to see how much you can spend on a given marketing channel to acquire a customer while still remaining profitable. It also lets you discover the most profitable marketing channels & campaigns. For example, you may want to see how valuable customers acquired through Facebook Ads are vs. customers acquired through Google Adwords. This can also be applied to non-paid acquisition channels such as customer’s acquired through email marketing campaigns or organic search.
2) LTV needs to include Gross Profit margin in the calculation
Most LTV/CLV calculation methods tell you to simply use your store’s overall gross margin. However, in order for this calculation to be accurate, it must take things like cost of goods, shipping costs, transaction fees, discounts, and refunds into consideration.
3) Customer “Lifetime” / Lifespan portion of the calculation
Average Customer Lifespan is the amount of time you expect to retain customers, typically measured in years. The Average customer lifespan can vary greatly on your store type, customer satisfaction, the types of products you sell, and how often your customers view or remember your brand. 3 years is a good rough number for a new but healthy ecommerce store. If you are dropshipping or have a hard time re-engaging customers with your store, you may want to use 1 year. If you have a subscription business, you would want to use a different calculation (see contractual vs. non-contractual CLV methods).
How to Correctly Calculate Customer Lifetime Value
Still confused or having trouble calculating these metrics? Our software, Ordermetrics, allows you to accurately calculate LTV on demand across all of your marketing channels.