Lifetime Value of Customer – Definition

Cite this article as:"Lifetime Value of Customer – Definition," in The Business Professor, updated December 16, 2018, last accessed June 3, 2020, https://thebusinessprofessor.com/lesson/lifetime-value-of-customer-defined/.

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Lifetime Value (LTV) Defined

The life time value is regarded as an estimate regarding the average revenue that the company is going to generate from the customer during the lifespan of customer or company.

The customer is attached to the company and spends money at the company throughout his life. This reality helps the company to make economic decisions.

In additional to projecting revenue, the company will use information about the customer unmaking decisions like marketing budget and sales forecasting.

How To Calculate LTV

The life time value of the customer can be calculated in the different depending upon the business model employed by the company.

For example, the life time value is a very important metric used in the subscription-based business model. This model calculates the monthly recurring revenue, known as MRR.

First, calculate the average monthly amount of expected revenue from each customer. This average is divided by the churn rate of the customer. Churn rate means the rate at which the company loses the customers each month.

This means that the life time value is the ratio of the average monthly amount expect from the customer to the rate at which customers are lost.

For example, if the average amount expected from the customer is $400 and the churn rate of the company is 0.04 or 4% , then the life time value is 400/0.04 = $10000. Then the average life time expected is given by $10000/400 = 25 yrs

In case of non-subscription models, Lifetime Value is calculated by multiplying the average order value by possible expected number of purchases by customers. In this model the average order or expected number of purchases by customers can grow or reduce over time.

How Is LTV Used?

Revenue forecasting is very important for any company because it shows the revenue earned by the company in future. The life time value has been the key variable for the company in revenue forecasting. The difficult lies in the fact that new or additional customers are always able to bring additional revenue every month to the company.

The life time value is helpful in determination of the marketing budget of the company. There are certain segments of customer that provide extremely value insights for he company. Notably, the acquisition cost is the cost used for acquiring the new customer or additional customers to the company. It is important to understand this metric for each market segment, as different marketing methods affect each segment differently.

The life time value is also used for the resource allocation for current customers. The customers with high life time value should receive more resource. Of course, the lifetime value is dependent on the customer’s stage in the customer life cycle, and the potential for renewal of the cycle.

How To Increase Lifetime Value

Increasing the life time value of new customer means:

  • Reducing the churn rate of the company.
  • Increasing the length of the customer lifecycle.
  • Increasing the average value of purchases per customer.

These will increase the long-term profitability of the company and make company stronger in competition.

Strengthening the brand name and trust among competitors is critical for retaining the customer and increasing customer base.

The non-subscription pricing model, increasing -add ons or up sells, is one of the effective methods of increasing life time value of the customer.

References for Lifetime Value

https://www.optimizely.com/optimization-glossary/lifetime-value/
https://www.thebalancesmb.com › Operations & Success › Market Research
https://chartmogul.com/metrics/ltv/

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