What is Lifetime Value?
A customer’s “Lifetime Value” in marketing represents the total revenue a business can expect from a single customer throughout their relationship with the company.
Lifetime Value (LTV) goes beyond the traditional view focusing on transactions, and looks at long-term engagement and value generated from each customer. This metric allows you to make informed decisions about marketing spending, customer acquisition costs, and resource allocation.
How to calculate Target ROAS
To calculate LTV, businesses need to consider three critical components:
- Average Purchase Value: The average amount spent by a customer per transaction.
- Purchase Frequency: How often a customer makes a purchase within a specific timeframe.
- Customer Lifespan: The duration of the customer’s relationship with the business.
Formula:
LTV = Average Purchase Value × Purchase Frequency Rate × Customer Lifespan
Let’s look at an example of three customers to illustrate how LTV can vary across different channels and customers:
- Customer 1 (acquired from Google Ads): made a single purchase of $50.
- Customer 2 (acquired from YouTube Ads): made an initial purchase of $40, then came back and made an additional purchase worth $80.
- Customer 3 (acquired from Instagram Ads): made an initial purchase of $20, but made 3 subsequent purchases of $50, $60, $30.
If you spent $25 to acquire each customer and only looked at revenue from the first purchase, you would calculate the return on ad spend as follows:
- Customer 1: $50 revenue / $25 cost = 2.0 ROAS
- Customer 2: $40 revenue / $25 cost = 1.6 ROAS
- Customer 3: $20 revenue / $25 cost = 0.8 ROAS
Based on the numbers above, Google Ads (customer 1) looks like your best channel. However, if you instead consider LTV (or revenue from all purchases) the calculation looks like this:
- Customer 1: $50 revenue / $25 cost = 2.0 ROAS
- Customer 2: $100 revenue / $25 cost = 4.0 ROAS
- Customer 3: $160 revenue / $25 cost = 6.4 ROAS (🏆 LTV Winner!)
Now Instagram Ads (customer 3) is your most profitable channel, since you are including all revenue and purchases.
See other marketing formulas:
Why is LTV important in marketing?
Understanding the lifetime value of your customer is more than a calculation or formula; it is a strategic tool for sustainable business growth. By knowing your customer LTV, you can:
Allocate Marketing Budget Effectively: With insights into how much revenue your customer can generate, you can make informed decisions on how much to invest in acquiring new customers and retaining existing ones.
Improve Customer Segmentation: LTV aids in identifying high-value customer segments, allowing for more targeted and personalized marketing efforts.
Enhance Customer Experience: By understanding the value your customers bring, you can create tailored experiences to increase customer satisfaction and loyalty, increasing LTV, and improving profitability for your business.
LTV and Customer Acquisition Costs (CAC)
The relationship between LTV and Customer Acquisition Costs (CAC) is a helpful metric to evaluate the sustainability of business strategies.
A healthy LTV to CAC ratio indicates a viable business model where the value derived from customers surpasses the cost to acquire them. Typically, an LTV to CAC ratio of 3:1 or higher is considered ideal.
Tips to improve your LTV
There are many ways to increase customer lifetime value. Here are a few:
Excellent Customer Service: Providing exceptional service and a seamless customer journey encourages repeat business.
Personalization: Tailoring your offerings and communications to meet the individual needs and preferences of your customers can increase engagement and spending.
Loyalty Programs: Implementing loyalty programs that reward repeat purchases can increase customer retention.
Improve Quality of Products and Services: Consistently delivering high-quality products and services builds trust and encourages customers to stay with your brand for longer.
Consistent Communication: Keep in touch with customers through newsletters, updates, and personalized messages to maintain a connection.
As with most smart bidding, there is a learning phase where Google’s bidding systems are working to hit your targets. While it is important to review your performance regularly, you should not make adjustments more frequently than every 1-2 weeks to allow for the system to optimize towards your targets.
Related glossary terms:
