Customer value or LTV in business

LTV (Lifetime Value) is the lifetime value of a customer. LTV shows the profit from the relationship with the client for the entire period - from the moment he saw the first advertisement or registered on the site until the last purchase. 

LTV affects the amount of revenue: the more regular customers a company has, the higher the income. But the indicator must be compared with other metrics. If the LTV indicator is high, but the company’s costs for producing the product, attracting and retaining customers are higher, then the business is not profitable and the overall strategy needs to be reconsidered.

Source: mango-office.ru

Why should you calculate LTV?

LTV is one of the most useful business intelligence metrics that helps increase profits while reducing costs. With LTV you can: 

• identify customers who bring the maximum and minimum profits in order to effectively allocate attention and resources;
• calculate how much money can be invested in the business and how quickly the costs will pay off;
• work to retain regular customers;
• analyze marketing effectiveness, determine where customers are coming from, and reduce costs on useless advertising.

LTV calculation formulas

There are several ways to calculate LTV - they depend on the size of the business and the number of factors that need to be taken into account. The more input data, the more complex the calculations. Let's look at the basic formulas.

Simple LTV Formula 

To calculate LTV, you need to find the values of two other indicators. 

The first is ARPU (average revenue per user). It shows the average income per client for a certain period. To calculate it, you need to divide the total income for the period by the number of customers for the same period. 

The second is Lifetime, the total period of work with the buyer.

LTV = ARPU x Lifetime

Let's look at an example: a monthly subscription to an application for tracking the activity of an athlete costs 253 hryvnia. On average, subscribers buy a subscription for six months at once. We calculate LTV: 253 x 6 = 1,518 hryvnia. This is how much money the average client brings in in six months.

Calculation using cohort analysis

A cohort is a group of customers with similar characteristics who made a purchase at a specific time or date. Using cohort analysis, LTV is calculated not for one buyer, but for a group.

You can calculate the LTV of users who registered on an online store’s website at different times - hours, days or months. When the cohorts are formed, the ARPU for each is calculated. To do this, add up the income from all clients of the group for a certain period and divide it by the number of people. The total amount of all ARPU during the entire period when the user makes purchases on the site is LTV. 

Using this data, you can track which marketing campaigns brought more loyal customers and identify points of growth and decline in user activity.

Traditional (expanded) LTV formula

Previous LTV calculation methods help you analyze past performance. The traditional formula is more complex, but it allows you to predict LTV in the future.

This is what the formula looks like: 

LTV = GML / (R/(1+D-R)) 

GML is the average profit per client over the entire period of working with the company. It is calculated as the product of the profit ratio (AGM) and the average order value for a certain period (AOV).

R - retention rate, shows the percentage of customers who return for a repeat purchase. It is calculated using the formula: 

R=buyers at the end of the period - new buyers during the monthbuyers at the beginning of the period 

D is the average discount that the company provides. If the calculation is a long-term forecast, then the discount rate is used. This is an interest rate that allows you to calculate the value of future money at the time of calculation. 

Let's forecast LTV, for example, for an advertising agency for the next quarter. The director is registered as an individual entrepreneur and pays taxes and social contributions, rents premises in the center, buys the best materials for work and advertises on social networks. The profitability ratio (AGM) is 50% or 0.5, and the average check (AOV) is 2,500. Then according to the formula:

GML=0.5 x 2500=1250

 Now we calculate the retention rate. Let's say that at the beginning of March the agency had 70 clients, and at the end of May - 90. Of these, 8 clients left, but within a month 28 new ones appeared. Then:

 R = (90 - 28) / 70 = 0.89

The administrator gives a 5% discount on repeat orders. Let's take this into account in the calculations and substitute all the values into the formula:

LTV = 1250 x (0.89 / (1 + 0.05 - 0.89)) = 6953

It turns out that taking into account the retention percentage and the size of the discount, the agency receives approximately 6,953 hryvnia per quarter from one client. This figure must be taken into account when planning advertising and other costs. 

How to calculate LTV in an analytics system

Google Analytics

To ensure accurate analytics, select the appropriate period - it depends on the specifics of the business. If you sell goods that are purchased several times a month, for example, coffee, then the calculation for six months is enough. If you are engaged in construction, it is better to calculate LTV over several years.

Set the period and select the “Sessions with transaction” segment and then the "Channels" report. Here you can see information about income and number of customers. The algorithm for calculating LTV in Google Analytics is similar: income over a certain time must be divided by the number of users who made transactions. 

Google Analytics also has a “Total Value” report, and in it the “Revenue per User” indicator, where you can see how the amount of income per visitor who performed an action on the site has changed. But it has disadvantages:

the indicator is calculated based on the last 90 days;

takes into account not buyers, but all site visitors.