Sometimes increasing your profits is about reducing costs. But sometimes it’s about maximizing the value you get out of your customers and individual orders. In this portion of our Profit Guide, we cover both elements of maximizing customer lifetime value (LTV) and average order value (AOV).
- Customer Lifetime Value and Customer Acquisition Costs
- So, What is LTV?
- Why Calculate Customer Lifetime Value?
- How Do You Calculate LTV?
- How To Improve LTV
- The Bottom Line of LTV
- Increasing the Average Order Value for your Ecommerce Store
- Why Average Order Value is Important
- Average Order Profit
- How To Grow Your Average Order Value
- “Frequently Purchased Together”
- Shopify App Recommendation
- Show Popular Products
- Upgrades & Customization Options
- Set A Free Shipping Threshold
- Set Up Loyalty Programs
- Offer Free Returns
- Post Purchase Upsell
- About This Guide
- Why Should You Trust Us?
Customer Lifetime Value and Customer Acquisition Costs
When you’re trying to increase the overall profitability of your online store, there are a few options.
- Acquire new customers
- Get previous customers to come back and buy more/again
- Cut costs
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 (and takes less effort as well). Here we talk about the Customer Lifetime Value, what it means, and how to grow it. We 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 lifetime value is one of those questions that more people should know the answer to.
It seems everyone knows that they need to know customer and order value – they just don’t know what to do about it. So let’s break it down and make it easy for you to calculate and improve.
So, What is LTV?
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.
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.
Why Calculate Customer Lifetime Value?
There are many good reasons to know your customer LTV but the most important one for most marketers is this: your LTV 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.
How Do You Calculate LTV?
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 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 and 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 Lifetime 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’re just starting off, or have less than two years in business, we recommend only using the Customer Lifetime Value metric, or just one year’s repeat business, in acquisition marketing.
We also suggest three 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, OrderMetrics 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.
How To Improve LTV
Now that you understand LTV, how it’s calculated, and why it matters, it’s time to address 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 that “doing right 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:
- Inspire Brand Loyalty: This is first because it is the most important. To succeed in the long term, you need to make a brand that is going to inspire customer loyalty. Pursue something unique and different that sets you apart from the competition. Invest in online content that tells a story and makes people feel like they want to join you for the ride. At Social Print Studio, we found that little touches like signing our automated emails from a friendly robot made our customers extra loyal.
- Know Your Buyer Personas: You need to understand the different types of customers you attract; there is no one-size-fits-all LTV. Some segments of your best customers might have an LTV of 5 times your regular customers. You should try to sort your customers out into groups, based on their LTV (Order Metrics can help with this!). You can export lists of their email addresses, and use Lookalike or Custom Audiences features on Google/Facebook to find more people like them, and target them with more ads. If you want to build out your personas with more detail beyond LTV read Shopify’s excellent guide.
- Measure LTV By Marketing Channel: Similarly to the buyer Personas, you can also measure LTV by the different marketing channels you use. Are customers coming from Google Ads more valuable than customers coming from Facebook Ads? If you can configure out where your top customers are coming from, you can decide how to improve your ad targeting to attract more people like them who will love your brand and spend more cash.
- Pricing & Loyalty Discounts: This might surprise you but you can improve LTV by offering discounts, rewards and loyalty. Consider using Smile.io to build a loyalty program, or learn more about price experimentation in our Pricing Guide
According to Alex McEachern at Smile.io – Topps grew LTV 48% by using a Smile Loyalty Program
- Invest in Customer Service: 51% of customers will never do business again with a company that provides them with a bad customer service experience. You need to ensure your chatbots or auto replies, as well as call lines, are stacked with positive and informative people that create amazing experiences on your behalf.
- Make Checkout Easier: 74% of consumers scrap a product or service if the online checkout is too long or complex. How many steps is your checkout funnel? Try and keep it as simple and easy to navigate as possible for your customers. You might get that first purchase, but a painful checkout will definitely stop someone coming back again.
- Invest in Convenience: Related to the checkout flow, if you want customers to come back, your product has to be convenient. You might have some barriers to this, like making customers dig around for coupon codes before ordering, or requiring log-in before people can browse your website. Maybe you can send customers reminders to re-purchase at specific time intervals so they don’t need to remember?
The Bottom Line of LTV
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 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.
Increasing the Average Order Value for your Ecommerce Store
Average Order Value is pretty simple. It’s just the average dollar amount a customer spends at your store in one order.
You calculate average order value by dividing your total shop sales by the quantity of orders placed.
Expending effort to increase your average order value can be more impactful than trying to acquire new customers, up to a point. If your business is set up to have a higher AOV, the value of any new visitors who come to your site will increase.
Growing your AOV is one of the keys to increasing your shop’s overall profit margin, especially when you can get your retail sales to grow at a faster rate than variable costs. Of course it’s still critically important to also knowing your Average Order Profit.
Arguably more important than having a good AOV is having a good Average Order Profit. We l get into that, exploring tactics relevant to both AOV and AOP.
Why Average Order Value is Important
First, earning more money on every order is pretty good. That’s the goal. The higher your AOV, the fewer customers you need to acquire and deal with.
Second, with a higher average order value, you have more cash to spend on acquiring customers and advertising. But a low average order value can be extremely limiting – you can’t spend so much to acquire customers and so you can’t afford to make mistakes.
At a minimum, for e-commerce, your Average Order Value needs to be less than your CAC (Customer Acquisition Cost). Having said that, I don’t recommend using AOV as the main comparison to CAC – I recommend using your customer Lifetime Value (LTV) for that.
But there are other reasons you will be hurt, beyond having limited acquisition spending, when your Average Order value is low. Other costs like credit card processing fees & shipping take a bigger chunk of your profits. Imagine you have a $12 AOV – the $0.30 transaction fee that you usually pay (alongside the 2.9%) to the credit card company is going to hurt more.
So with a higher AOV, you can spend more on ads, you will have more profit, and the work you do elsewhere to acquire customers will have a greater effect.
Sounds pretty good, right? So let’s get into the tactics for how you can set the stage to grow AOV for your store.
Average Order Profit
Average Order Profit does not take into account the marketing and ad spend to acquire the customer. But it does take into account all the other costs you incur such as COGS, transaction fees, shipping & discounts applied.
For that reason, it is a more intelligent metric to use when deciding where to allocate your spend on operational expenses and marketing costs.
Average Order Profit can be a little trickier to calculate – most analytics tools can’t tell you this because they don’t know all your costs.
OrderMetrics shows you both of these numbers, as well as your Lifetime Value (LTV) on the main profit dashboard.
As you read through this guide, try to consider the impact of these tactics on both AOV and AOP.
How To Grow Your Average Order Value
Once a customer is close to making a purchase, you can try to subtly (and not-so-subtly) offer them upgrades and extras. There’s a careful balance here, to avoid overwhelming your customers before they make their first purchase, but done correctly, you can nudge customers towards adding more items to their cart to improve your Average Order Value. This also plays into your pricing strategy, discussed in another section of the Profit Guide.
“Frequently Purchased Together”
Showing your customer items that compliment the item in the cart.
For instance if you sell posters, you could have frames or poster hangers shown in the cart. These work well if you can easily add them to the cart with one click for an impulse additional purchase that boosts AOV.
OrderMetrics shows all your most common products purchased together, and you can sort them to show which combinations are the most profitable. Use this to help inform your decisions.
Shopify App Recommendation
On the Shopify App Store there is a great app called Frequently Bought Together, aptly named and well reviewed. It automatically figures out which products are purchased together, and shows them to customers.
Show Popular Products
An alternative to showing “items frequently bought together”, you could show instead the most popular store items on your cart page. The social proof that items are popular is often the extra encouragement customers need to add something to their cart.
Upgrades & Customization Options
Some products lend themselves well to customization. If you sell bathrobes, you could have “add a monogram” option that costs an extra $7.
If you sold Tesla cars, you could have an upgrade option to get a longer range battery pack!
Once someone is about to buy a product and realizes it could be improved for a small amount extra, they will often go for it.
If you have two or three items that go well together, you should make a new product that combines all the items in one.
For each bundle, set a price so that customers receive a small discount off the regular price for buying all three items. A bundle like this will encourage customers to spend more and grow your AOV because they are “saving money” by buying more items.
You could also theme your bundles, to keep them fresh. Primitive Skate, a hip skateboarding shop in LA, made a 2018 Holiday Bundle for $100 that includes 8 items – a great example of how to make a bundle feel like a special purchase.
Set A Free Shipping Threshold
Everyone loves free shipping. In fact, research suggests that some customers will not check out without it. If you offer free shipping over a certain price, often customers are happy to add a second item to their cart just to “save on shipping”. We’ve all gone for it.
The trick when deciding how to set the free shipping threshold is to start with your current Average Order Value and then increase that by 10-20%. So if your average order value is $35 – try to set free shipping for orders over $40 (assuming this would still be profitable!).
Set Up Loyalty Programs
Getting your best customers to come back more often can boost average order value (as well as Lifetime value).
This is because customers who return are likely to spend more money the second time around than the first.
You can nudge this to happen more frequently by sending customers a coupon after they complete an order. Something like “You’ve earned $5 off your next order!” can be extremely effective. This acts as a loyalty deal – if they come back, research shows they spend more, and this coupon can help ensure that.
Offer Free Returns
Offering free returns encourages people to buy more, because there’s less risk, if they don’t like something they feel they can send it back. It might cost less than you think to add a return label in every box.
Post Purchase Upsell
A more recent innovation in e-commerce is the post-purchase upsell. Once a customer has just placed an order, you show them a pop-up saying “For An Extra $XX – Add This To Your Order”. There are various ways you can implement this on your site, and we have heard of people reporting up to 10% of customers will convert on a post-purchase upsell.
This could be an especially good tactic to boost Average Order Profit because typically each additional item that you send in one package increases the overall profit margin of the order.
A tool called Carthook is proving to be quite popular and you can use it with Shopify stores (or other types of store too), and add post-purchase upsells to your site.
The Bottom Line
The best way to use any of these tactics is to find graceful and natural ways to integrate them into your site. People can sense when you are desperate for an extra sale and will shy away from the purchase. Make sure recommendations of upsells appear naturally in their flow, and don’t try to trick people into clicking things or overloading customers with options.
After you have a few of these things set up, you will be in a good place to attract customers to your store. That’s because you have things set up to succeed, the customers you drive to your site now can be fully capitalized on.
Finding ways to nurture repeat customers to grow the lifetime value of a customer and nurture a customer’s buying journey to maximize order value work hand in hand to boost your profits.
About This Guide
The Order Metrics Profit & Growth guide is designed to help you unlock the most profit for your e-commerce business.
Why Should You Trust Us?
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.
Additional help was provided by Hank Kronick, founder of Order Metrics. In some cases we worked with researchers 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.
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.