Life Time Value, or LTV, is one of the most important metrics when it comes to any business, but especially for an online business. It is, therefore, a big surprise for me that few companies that I have been associated with use this metric actively when it comes to managing their business.
LTV simply measures the value of a customer to your business. To calculate it, you need to have an understanding of how long can you get some revenue from your customer (the Life Time) and the total revenue you can receive from the customer during that period of time (the Value).
Let’s take an example. Let’s assume that the average customer purchases from your site for a period of 2 years, and makes purchases worth Rs. 2,500 in the first year and Rs. 1,000 in the second. Let’s also assume that you make a flat 20% margin on the sales.
So, in this case, the two-year LTV of your customers would be Rs. 500 (Rs. 2,500 * 20%) + Rs. 200 (Rs. 1,000 * 20%) = Rs. 700.
This means that, on an average, you make Rs. 700 from every customer you acquire.
An immediate application of this is that you now have a target for your Customer Acquisition Cost (CAC). If you wish to make a profit from every customer you acquire, then you cannot spend more than Rs. 700 to acquire a customer. Or, if you wish to make a profit of Rs. 200 per customer, then your CAC has to be less than Rs. 500.
Given the challenges with multi-channel and multi-device attribution, in my opinion, Customer Acquisition Cost, or CAC, should be the primary metric driving customer acquisition. However, I find very businesses adopting this, but that is a topic for another article!
Understanding LTV at an individual customer level also helps businesses create a highly targeted Customer Relationship Management strategy. One can create segments of users based on their relationship to the standard or expected Lifetime purchase behaviour and craft tailored messages, including offers, to those users who might be below the average LTV. Similarly, users with high LTV can be identified and developed as potential promoters / influencers.
So why do very few businesses adopt this key metric?
In my opinion, these are some of the challenges:
- Lack of awareness and understanding of the metric – In general, most people are comfortable with pure transactional metrics. How many customers, sales, revenue did we make? And how much did we spend to make this sales? LTV, by definition, is a long-term metric. A business might only make profits from acquired customers after 6 months, 1 year or longer.
- LTV is not a leading metric – As I mentioned previously, LTV is a long-term metric. For a new business, it might take up to a couple of years before they can realistically calculate their LTV. In the interim, they rely on more immediate (or leading) metrics to measure and run their business. And once they get comfortable with this, there is a natural and understandable reluctance to shift to another metric.
- Lack of appropriate measurement for channel of customer acquisition – Measuring visits and conversions from a marketing channel is pretty straight-forward. However, tracking of new customer acquisition is a slightly trickier exercise. It typically requires some additional technical requirements to map a new customer back to the channel (either first or last) that led to that customer visiting your site and making their first purchase.
- It takes time and effort to move the LTV needle – By it’s very nature, it takes a lot of time and sustained effort to move the needle when it comes to LTV. So, any business that wants to work with this metric would typically have to look at some element of the metric where short term movements are visible. For example, it could be one cohort of users, or a specific period in the Life Time, as opposed to the full LTV. As you can imagine, this brings in a degree of complexity from an analytics perspective that many businesses might not be resourced effectively for.
- Team structures and goals – LTV is a difficult metric to break down for the various teams that are directly responsible for it. Many marketing teams are still structured on a channel basis. And it can be difficult to translate the LTV goal into an effective metric that operations and delivery teams can manage to.
Despite these challenges, I believe that every organisation, especially digital native ones, should have Life Time Value (LTV) as one of the key metrics that they measure and grow. It can provide both strategic as well as tactical insights that can prove very useful to scale their business in a sustainable manner.