Also known as Customer LifeTime Value (CLTV), LifeTime Value (LTV) is the money we obtain from a customer over time. This value can be calculated using the following formula:
It is important to keep in mind that LTV is sometimes calculated without considering gross or net margin. Therefore, to avoid confusion, it is essential to clarify which values have been considered in the formula.
When the business model is recurring, other acronyms are often used, such as Average Revenue Per User (ARPU).
But is a business with an LTV of $75 worse than one with an LTV of $300? It is important to understand that the LTV metric only makes sense when related to CAC (Customer Acquisition Cost), because what ultimately matters is real profit. This leads us to think that the $75 LTV business may actually be better, because its costs are relatively lower than those of the $300 LTV business.
How to calculate LTV
When calculating LTV, many entrepreneurs run into a problem. If their business has only been running for a short time, they cannot know what the "duration" of a customer will be, nor how many times that customer will buy over time. In other words, they do not know the LifeTime, or the average time customers remain active.
However, what they can know is the average money a customer leaves each time they buy, regardless of the gross margin of the business.
Churn
As we have seen, knowing the LifeTime (LT) of your customers can be very complicated, not only because your business may have been operating for a short time, but also because of the calculation difficulty involved. For this reason, I recommend using an approximation, which can also provide great value.
Knowing the churn the business has had during the last month allows you to estimate its LT and LTV.
In businesses where repeat purchase is essential, having a very low churn rate is vital, because it has a direct impact on revenue. It may seem that there is little difference between churn of 1% and 2%. However, the latter is double the former, which means that revenue per user (LTV) could be cut in half.
By introducing LifeTime (LT) into our LTV formula, we obtain a new way to calculate it:
How to improve LTV
To improve LTV, we need to look at the elements that make it up and try to improve each one. In this case, since all the metrics are multiplied, they will have the same sensitivity and will affect the result equally.
Increase AOV (Average Order Value)
AOV measures the average amount of money spent per transaction. Increasing AOV is one of the most effective ways to grow revenue without acquiring additional customers.
To achieve this, businesses can:
- To increase the number of products, we could create different packs or recommend the purchase of another related product (cross-selling).
- To increase the average product price, up-selling techniques can be used, meaning recommending more expensive products. We can also change the product portfolio to increase the average price.
Increase ARPU (Average Revenue Per User)
ARPU measures the average revenue generated by each customer over a given period and is particularly relevant for subscription-based and SaaS businesses.
To increase ARPU, companies can:
- Encourage customers to upgrade to higher-tier plans with additional features, capacity, or support.
- Introduce premium add-ons and complementary services that generate additional recurring revenue.
Increase LT (LifeTime)
By increasing LifeTime (LT), we retain customers to a greater extent while also reducing churn. We will cover this topic in more detail in the section dedicated to churn.
Increase gross margin
The options we have to increase gross margin will depend largely on the nature of the business. For example, if we are talking about an e-commerce business that sells products manufactured by other companies, the main option would be to improve the cost of each product or introduce a higher profit margin into its sale price. If, on the other hand, the business manufactures its own products, it would need to look for a reduction in manufacturing costs.
Improving LTV summary
In summary, the main options for improving LTV are:
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