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Why you should calculate your customer lifetime value

Your customer matters more than a single purchase. But how much more? The ‘how much’ part is called the ‘customer lifetime value’. Not knowing this important calculation is no better than lacking an appreciation for the value of the service you’re offering.

Customer lifetime value (LTV)  is the monetary value that a customer can offer during the entire span of their relationship with your brand. There are many ways that this can be calculated  but the following method is the most easily obtainable measure of LTV:

(avg. value of sale) x (avg. number of repeat purchases) x (avg. retention time)

Let’s break this down even further:

Average value of sale is the monetary average of an individual sale. This is determined by calculating the total sales revenue for the year and dividing it by the number of sales for the year.

Example: R 5 000 000 sale value / 50,000 sales = R 100 per sale

Average number of repeat purchases is the amount of times a customer is likely to purchase goods from you. To calculate this, take the total number of sales for the year and divide it by the total number of unique customers for the same year.

Example: 30,000 sales / 10,000 customers = 3 sales per customer

Average retention time can be defined as the number of years a customer shops with you.

Calculating retention time in two easy steps:

Step 1: Calculate the churn rate. Churn rate is the drop-off percentage of customers from one year to the next (the percentage that you keep is your retention rate).

Example:

15,000 customers (2015)

10,000 customers (2016)

Retention rate = 67%

Therefore, Churn rate = 33%

Step 2: Once you have your Churn rate and Retention rate, calculate your average retention time using this formula:

Example:

Retention time = 1/churn rate

i.e. 1/33%

= 3 years

Now, with these results, you can calculate LTV = R 100 x 3 x 3

Therefore: LTV = R 900

Knowing how much value you can expect of your customers, means you can strategise accordingly. An effective approach is to create ‘value segments’ based on the current spend of your customers, and design multiple strategies that suit each specific segment. You’ll also be able to maximise your marketing budget with a firm grasp of what your target CPA and return on investment should be.

Operating without an understanding of your customer lifetime value will disorganise your business and engage you in constant analysis of your budgets and targets. Run your business skillfully and carefully, with direction and ambition. Success is about more than just a single sale.

By Yazeed Osman, CRM Specialist

Yazeed has helped many companies improve their customer experience by implementing data led initiatives. He’s also founded, Usfl, a local UX design & Behavourial Marketing company focused on customer relationship management.