The Challenge of Calculating Customer LTV

Ido Shichor
Ido Shichor

Co-Founder and CEO of iKnowlogy Ltd. - Data science and BI professional services.

Customer Lifetime Value (LTV) is the total monetary value of your average customers who will do business with you over a period of time. From a business perspective, calculating LTV helps you gain insights and marketing strategies to maintain profit. Using Customer Acquisition Cost (CAC), it is possible to measure the average profit of a customer.

However, many free tutorials and free software tools provide only an estimate of LTV. Such estimates might come in hand, but the effective use of Customer LTV to optimize business profitability must be based on accurate calculations that are based on granular data of revenue, expenses and attribution of revenue to marketing channel.

Regardless of the free tools and methods for estimating LTV, online companies such as retailers, SaaS and game developers face several obstacles when calculating and analyzing LTV as a part of their day-to-day data-driven operation.

These include:

  1. Marketing Attribution – It is not enough to calculate LTV; you need to be able to drill down per marketing channels and campaigns or you will not be able to do any optimization.
  2. Factor in Expenses – If you look only at revenue you will not optimize for profit. Your Customer LTV calculation must consider also expenses for marketing, COGS, infrastructure, shipping, discounts, etc. Gathering all data sources might be a tedious task.
  3. “Lifetime” vs. a timeframe you can work with – LTV is mainly used to analyze marketing channels and campaigns, but how can you calculate the LTV of customers that joined in the past week for their entire lifetime (that may be several years in the future). 

Let’s take a closer look…

Marketing Attribution – Calculating LTV per traffic channels

This approach is critical to optimizing your marketing budget. It enables to measure the marketing channel strategy used to attract new customers and to increase profitability. It also allows you to discover more profitable and suitable channels to run campaigns. For example, you can check how valuable customers can be acquired through Facebook Ads compared to Google Adwords. This strategy can also be applied to non-paid customer acquisition tool, mainly through organic search or email marketing campaigns.

Factor In Expenses

Customer LTV is metric that can have an impact if used for optimization. The metric that should be optimized is the average profit per customer be eliminating negative profit products / campaigns / promotions. The only way that your Customer LTV calculations help your business is if you factor in those expenses to the calculation. Additional expenses that should be included are billing fees, shipping costs, refunds and charge backs, cost of returns.

Don’t Wait For a “Lifetime”

If we had to wait for customers to complete their activity with us and churn to calculate LTV, it wouldn’t be a feasible mechanism to work with. We need to work with a LTV metric that can help us compare the performance and profitability of campaigns withing the first days of new customers’ activity. There are 2 solutions to this problem:
1) Predicting customers LTV based on their activity in the first days. This method can be used by very advanced and large companies because it takes a considerable effort to do it right.
2) Using proxy KPI’s. For example, by calculating 30 days customer-value we can get an accurate calculation that will allow us to compare campaigns performance long before the customer lifetime is complete.

Need help??

We have 2 additional resources for you:

  1. North-Dash – You might still be confused by all of this… after all, how exactly can you consolidate all of the required data together and create an automated solution that let’s you work with Customer LTV on a day to day basis. Our solution, North-Dash, does exactly that.
  2. Get our whitepaper – We wrote a great paper about many aspects of customer LTV along with real customer stories. Leave your details below to receive a copy.
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