Which of the following is the formula for calculating the lifetime value of a customer?

The process by which a business measures the value of a customer to the business through the customer’s full lifespan

What is Lifetime Value Calculation?

Lifetime Value Calculation is the process by which a business measures the value of a customer to the business through the customer’s full lifespan. Customer Lifetime Value or LTV is one of the metrics used to measure the growth of a company.

By comparing the LTV of a company to the cost of customer acquisition, it can calculate the value of a customer to the business over the period of time that they were associated with them. The LTV helps a company gain and retain highly valuable customers.

What is Customer Lifetime Value (LTV)?

The customer lifetime value (LTV), also known as lifetime value, is the total revenue a company expects to earn over the lifetime of their relationship with a single customer. The customer lifetime value calculation accounts for the customer acquisition costs, operating expenses, and costs to produce the goods or services that the company is manufacturing. Many companies tend to overlook the LTV metric but the lifetime value of customers is essential to the growth of a company.

The lifetime value calculation is given as:

How to Calculate the LTV of a Company?

• Average purchase value – It is calculated by dividing the company’s total revenue over a period of time by the total purchases made by its customers during that same timeframe.
• Average purchase frequency rate – It is calculated by the total purchases made over a period of time by the individual customers that made those purchases during that time.
• Customer value – It is calculated by multiplying the average value of the purchase by the number of times the purchase is made.
• Average customer lifespan – It is the average number of years that a customer continues to buy the company’s goods and services.
• Lifetime value calculation – The LTV is calculated by multiplying the value of the customer to the business by their average lifespan. It helps a company identify how much revenue they can expect to earn from a customer over the life of their relationship with the company.

Numerical Example

The average sales in a clothing store are $80 and, on average, a customer shops four times every two years. The lifetime value is calculated as LTV = $80 x 4 x 2 = $640.

Furthermore, the profit margin in the clothing store is 20%, hence the CLV is as follows: CLV = $80 x 4 x 2 x 20% = $128.

The lifetime value figure can help a business estimate future cash flows and the number of customers they need to obtain to achieve profitability.

What Factors Contribute to Lifetime Value?

The lifetime value of a business depends on how popular the brand is among customers. For example, if a customer lacks any loyalty to the brand and does not face any switching costs when buying a rival company’s product, it can result in a negative impact on the lifetime value of the company. Following are the factors that affect the LTV of a company:

1. Churn rate

The churn rate describes how often customers stop shopping at a business that they were once loyal customers of. The rate can differ from business to business and depends on the competitive advantage of the company and their ability to keep customers interested in their products. Usually, small businesses and startups tend to face a high churn rate.

2. Brand loyalty

It measures how loyal the customers are to the brand and who keep buying their goods and services. Building brand loyalty can help retain customers and decrease the churn rate. A company with a lot of loyal customers will generate a high lifetime value.

How to Increase the LTV?

There are many tactics that businesses can implement to boost efficiency and increase customer retention rates, thereby increasing their LTV:

1. Good communication

Open communication between the business and the customer can help a customer relate to the brand better. It is important for companies to listen to feedback from their customers as it can help them improve and grow. Effective communication reduces the churn rate as well.

2. Re-engage customers

An effective way to increase LTV is to engage with customers who previously purchased goods and services from the company. It is particularly useful for companies with a long shelf life, and it can help improve brand recognition.

3. Increase brand loyalty

The lifetime value of a company can help with future growth projections and increase profitability. LTV can be increased by implementing strategies to increase brand loyalty.

Related Readings

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

• Cost of Goods Manufactured (COGM)
• Customer Profitability Analysis
• Types of Customers
• Walmart Marketing Mix