When you are trying to increase the overall profitability of your online store, you have a few options.
Acquiring a new customer can be very expensive - and the cost seems to be rising all the time as online advertising gets more competitive.
That's why placing your focus on getting your customers to come back can be the highest-value activity you can do - less effort as well. Let's talk about the Lifetime Value of a Customer (LTV), what it means, and how to grow it.
First we’re going to look at what LTV is, how you can calculate it, what it means for your business, and then critically, steps you can take to improve your overall LTV moving forward.
Knowing your customer's lifetime value is one of those questions that more people should know the answer to.
In fact, it seems everyone knows that they need to know it, they just don't know what to do about it. We are going to try to break it down and make it easy for you to calculate and improve.
This was written by George Sylvain, co-founder of Social Print Studio, a successful e-commerce store that has been selling prints and profitable for 8 years. Social Print Studio has unusually high repeat customer rates of over 60%.
Additional help was provided by Hank Kronick,founder of Order Metrics. In some cases we worked with researchers & outside experts to make sure we covered all angles. We have a combined 16 years of e-commerce experience and have personally the techniques described in this guide, and seen the results in practice.
LTV is a rather simple statistic concept: it refers to the profit or revenue that is generated from one customer throughout their commitment to the company.
There is Gross LTV, which is the total revenue that customers bring in over their lifespan, as well as Net LTV, which is the total profit from each customer over their time as a customer.
It is generally accepted the the higher your purchase frequency and the larger your customer base, the more critical your LTV will be for your business to factor in future decisions.
For example, a company with millions of customers would like to know which customers are bringing in more value and why; whereas a small business with 5 customers doesn’t really need the math to help them figure out who is spending more.
There are many good reasons to know your customer Life Time Value but the most important one for most marketers is this. Your Life Time Value will inform how much you can spend to acquire a new customer.
Once you spend more than your LTV on a customer, you are spending more than you are getting back. In fact it would be ideal for you to spend far less than your LTV on a customer. How much less?
Most people agree that your Cost to Acquire a Customer (CAC) should be approximately 1/3 of your LTV at most. Order Metrics helps you with this by showing the CAC:LTV ratio for each ad you run, in our attribution analysis.
To calculate LTV at your company, we recommend using a Net LTV calculation.
To do this, you need an accurate idea of all the costs associated with each individual order - such as shipping expense, cost of goods, any fees, and the average level of refunds too. Too many people & services out there are calculating LTV based on revenue alone, or using rough estimates for costs, and this can be an extremely dangerous way to run your business.
Don't rely on any LTV calculations that expect you to estimate your gross margin and apply that to average order value.
Any wrong assumption could jeopardize your use of the LTV figure down the line.
We believe you need to get strict about accuracy, and you should take into account true cost of goods, actual shipping costs, transaction fees, discount codes used, & refunds for each order. The only expenses you should not include are marketing expenses e.g ad spend. Only then can you have serious confidence in your LTV to make spending decisions with.
To calculate the LTV - account for all costs precisely and then start by calculating Customer Value first.
Customer Value is an excellent metric to use when developing your marketing budgets. To add the Lifetime component to Customer Value, you need to figure out how many years you expect to retain customers. Many people get wildly optimistic about this, especially in combination with that dangerous drug known as VC investment cash. We urge caution at first, unless you have extremely deep pockets. Many an e-commerce store has gone out of business by over-estimating the lifetime value of a customer and then overspending on acquisition. If you are just starting off, or have less than 1-2 years in business, it's not going to be easy to come up with an accurate number for lifetime, and we recommend only using the Customer Value metric, or just 1 year's repeat business, in acquisition marketing.
If you must have a lifespan, we suggest 3 years at the highest for a healthy ecommerce business. If you want to go higher, hopefully this is based on a serious lengthy track record.
LTV is calculated as follows:
If you are having any difficulty calculating these essential metrics, I will make a rare plug for our software and suggest Order Metrics for your store. We automatically calculate the CV and LTV for you based on the actual figures from your Shopify store, Shipping providers, transaction fees, refunds and more, giving you numbers you can really trust.
Now that you understand LTV, how it’s calculated, and why it matters, it’s time to ponder how you can improve your personal LTV at your operation.
At Social Print Studio, we consider a good Life Time Value as an important metric, but also a side-effect of how we choose to run the company. Customers are looking for certain level of attention and support at the end of the day. I found by "doing the right thing by the customer", we were able to grow LTV.
Here are just a few tactics to get it moving up again, you'll notice most are very customer friendly improvements:
LTV helps you learn how profitable customers are, and therefore how much you are can spend to bring them into your community. From this metric, you can start to understand your loyal shoppers, who they are, what they like, and how they respond to your sales/new product listings.
Your competitors are likely using LTV as a measure to acquire customers. If you are lucky, they will be calculating their LTV wrong and go out of business. If you are more on top of these numbers than they are, you might be able to get ahead. It’s a metric that should inspire you to make smart changes.
LTV is just the beginning. There are not many shortcuts. But heed our advice, invest in quality, simplicity & brand, as customers begin to love you more, you will start to see LTV going up.
The Order Metrics Profit & Growth guide is designed to help you unlock the most profit for your e-commerce business.
This is not intended to be nonsense content marketing like you find on other company blogs.
These are real, tested techniques could help you grow your business and put some cash back in your pocket so you can invest in things that matter to you.
Check out the other articles we have written back at our profit guide index.
Check out Order Metrics - A profit management tool for growing ecommerce merchants. The best way to track and measure your e-commerce store performance across multiple storefronts , advertising providers and shipping providers. Customers report increasing their margin by 5-6 percentage points after using Order Metrics.