Customer Lifetime Value (LTV) - Part 1 - Definition

Picture1.jpg

With the rise of Direct-To-Consumer (DTC) and e-commerce businesses, there’s an increased focus on Customer Lifetime Value (LTV).  

Why should you care about LTV?
When used properly, LTV can be the backbone for Marketing decision making - including strategic planning, budgeting, and setting media/CPO targets.  This is why some DTC businesses seem to have endless media acquisition budgets.  They know and leverage their LTV.

Since everyone has their own interpretation of what LTV includes, how it's calculated, and how it should be used, we want to begin by offering our own definition of LTV.

LTV is what a customer is worth, outside the cost to acquire them.

But, of course, it is much more involved than that.  Let’s dig further by breaking down each word in “Customer Lifetime Value.”

“Customer”
You should be looking at the full relationship with a customer.  Not just one order, but a collection of all purchases the customer has made.

“Lifetime”
It is important to have a cumulative view of what that customer has purchased to date AND what you expect they will buy in the future. Revenue to date plus projections.  The projections are based on performance over a defined period of time - typically 3-5 years or more. When determining a timeframe that’s right for you, it’s key to line up your projection timeframe with your financial ROI goals.

“Value”
By value we mean margin, not revenue.  Margin is calculated by taking revenue and subtracting all contra revenue (returns) and variable costs (COGS, royalty, fulfillment, etc).  The result is your margin on a per customer basis.

In summary, LTV is the margin brought in per customer over a defined period of time.  A simple example:

A customer signs up for a $20 monthly subscription and they have been active for 3 months. Revenue to date is $60 ($20x3).  Based on similar customers you forecast they will stay active for 6 months. Lifetime revenue is forecasted to be $120 ($20x6). Your contra revenue & variable costs to service them for 6 months is $50. This brings you to a projected LTV of $70 ($120 projected revenue - $50 variable costs).

This LTV of $70 can now be used to set media CPO allowables, but more on that in our next blog post.

Having clarity on the customer, what’s included and subtracted to calculate margin, and the time period you’re measuring are all essential inputs into a successful LTV model.  This blog is the first in a series of three Directade blog posts about LTV - next time we will be exploring Applied LTV.

If you don’t have a Customer LTV, or if you’re unsure your current LTV is accurate, don’t be afraid to ask for outside help.  Directade provides marketing leaders with LTV models and analysis so they can be confident in their decision making.  Contact us to see how we can help your organization.