Discover what Lifetime Value (LTV) is and how it is calculated

Gonza Pastorino17 August

Lifetime Value or LTV: meaning, formula and its importance in marketing

In marketing, we can find a variety of crucial metrics to evaluate success and profitability. These include Lifetime Value, better known by its acronym LTV.

LTV is presented as a key tool for understanding the contribution that a customer makes to a company over time, reflecting the net value of the revenues that the customer generates during its period of commercial relationship with the company. LTV also plays a vital role in assessing the profitability of a business and discerning the effectiveness of strategies aimed at attracting and retaining customers.

In this article, we will explore what Lifetime Value is, how it is calculated and why it is a crucial metric in strategic decision making.

What is the meaning of Lifetime Value and why is it important?

The idea behind Lifetime Value is based on the idea that a customer is not just limited to making a purchase and that’s it, but can continue a long-term relationship with the company, generating revenue that arrives from time to time. In other words, the LTV is like an estimate of the profits that a particular customer can earn the company for as long as he remains its customer. It is important to consider LTV in marketing because it provides a more holistic view of the company’s profitability and allows informed strategic decisions to be made.

LTV is especially valuable when contrasted with customer acquisition cost, also known as CAC. If the LTV of a customer is higher than the CAC, it means that the business is profitable in the long term and that the acquisition strategies are working, i.e. the investment made to attract that customer will be exceeded by the profits that customer will bring to the company’s future. Conversely, if the CAC exceeds the LTV, it may be a signal that acquisition tactics need to be reviewed and adjusted to improve profitability and ensure that we are attracting the right customers.

Lifetime Value also helps us understand how long customers stay with us and whether they are happy with what we are offering them. For example, if a customer keeps coming back, it is likely that they are really satisfied with what we sell and how we treat them when they need us.

In addition, LTV in the marketing world helps us to see which groups of customers leave us with the most profit, so we can focus on keeping them happy and satisfied with what we give them.

At the end of the day, the goal of most companies is to generate value, and the more value generated, the better.

How is the Lifetime Value calculated?

Calculating Lifetime Value involves looking at a number of things, such as how much customers tend to spend on average when they buy, how often they buy, and how long they tend to remain our customers. The basic formula we use to derive the LTV is as follows:

LTV = Average Purchase Value x Purchase Frequency x Average Customer Relationship Length

To better understand the formula, let’s look at a practical example.

Let’s imagine a company that offers monthly subscription services for content creation with artificial intelligence for an average value of $50. On average, its customers remain subscribers for two years, and throughout that time, they make a monthly purchase, since the subscription is paid once a month. To calculate the LTV, we apply the formula:

LTV = $50 (average purchase value) x 12 (annual purchase frequency) x 2 (average length of relationship) = $1,200

In this example, the customer’s LTV is $1,200. This means that, on average, the company can expect to receive $1,200 in revenue from a customer for as long as it maintains the business relationship with them.

It is important to note that the LTV calculation can be more complex depending on the business model and available data. In some cases, additional variables may be considered, such as the profit margin per customer or the net present value of future cash flows.

Once the LTV has been calculated, the CAC must be subtracted. Assuming the CAC is $800, then it would make sense to have that customer, since it represents a profit of $400. This can be seen if we do the following math: $1,200 (LTV) – $800 (CAC) = $400. Conversely, if the CAC exceeded $1,200, the client would not be profitable.

Advantages of using LTV in business management

Adding Lifetime Value to how we run the business brings a lot of important advantages. It can really make a difference in how much money we make and the strategic decisions we make to grow. Let’s take a look at some of them:

1. Optimization of acquisition strategies: LTV allows you to evaluate which acquisition channels generate the most profitable customers and adjust resources to focus on tactics that deliver the best ROI.
2. Focus on customer loyalty: Satisfied customers are more likely to maintain long-term business relationships. By understanding the long-term value of each customer, companies can focus their efforts on retaining them, which in turn contributes to increasing LTV and reducing the cost of acquisition.
3. Effective customer segmentation: By calculating LTV for different customer segments, you can identify those groups that generate the most revenue and customize strategies to meet their specific needs.
4. Make informed decisions: LTV provides essential information to guide strategic decisions in areas such as marketing, sales and customer service. It allows you to define budgets, set objectives and measure the success of commercial initiatives.
5. Improved profitability: By properly balancing LTV with CAC, companies can ensure that their marketing strategies are sustainable and generate significant profits over time.

How to improve LTV?

Raising Lifetime Value is critical to increasing a company’s profitability and long-term growth. Here are some effective ways to achieve this:

1. Offer high quality products or services: Customer satisfaction is a key factor to maintain customers over time and to generate recurring income. By providing high quality products or services, trust is strengthened and customer loyalty is fostered.
2. Loyalty programs: Implementing loyalty programs rewards customer continuity with special incentives, discounts or exclusive benefits, which increases the likelihood of future purchases.
3. Adaptation and customer experience: Understanding customers and personalizing the experiences they have with the brand generates a feeling of affinity and emotional bond, which translates into a higher retention rate and a greater likelihood of recommendation to other potential customers.
4. Effective communication: Maintaining active and effective communication with customers, such as sending updates, special offers or relevant content, helps maintain their interest and engagement with the brand.
5. Upselling and cross-selling offers: Identifying opportunities to offer complementary products or services to existing customers increases the value of each purchase and, therefore, the LTV.
6. Remarketing Campaigns: Targeting remarketing campaigns to inactive customers can reactivate their interest and remind them of the convenience of continuing to buy from the company.

Lifetime Value: your ally in the quest for profitability

In summary, Lifetime Value (LTV) is a crucial metric in digital advertising to evaluate the long-term profitability of a business. Calculating LTV and considering it in business strategy offers significant advantages, such as optimizing acquisition strategy, focusing on customer loyalty and making informed decisions.

By increasing LTV through strategies such as improving the customer experience and implementing loyalty programs, companies can maximize profitability, build customer loyalty and achieve long-term success in an increasingly competitive marketplace.