Are you ready to implement Octopus into your daily work?
Octopus AI does not require registration, to log in, you just need to enter data from your account system, at the moment it is Xero or QuickBooks.
What is the meaning of customer lifetime value (LTV)?
What is the meaning of customer lifetime value (LTV)?
why it is important?
To understand how valuable a customer is to a small business, they need to calculate their customer lifetime value. This value represents the total profit that a customer brings to the business.
Let's use Zuzu eco-friendly sandals as an example. A customer might buy these sandals from Zuzu's website every year, spending an average of $65 per purchase. In our example, this customer continues to buy for two years before switching to another brand.

To calculate the customer lifetime value for this customer, multiply $65 by the recent gross profit margin and the expected period that this customer will continue to buy.
What are the limitations of LTV?
However, most early stage businesses may not have enough data to calculate LTV accurately. Did you know that Starbucks Customer LTV is over $14,000 just because Starbucks has been around since the 70s? So if Zuzu has only been around for two years and its calculated LTV today is $130, it completely ignores the future potential of this young company.

Further complicating things, LTV is used as a metric to determine when to increase sales and marketing spending. If the ratio is greater than 3x, then it's time to spend more. The challenge with this strategy is that it links today's marketing spend to the projected total profit from from a customer, which is difficult to calculate.

That's why in the early stages, the payback period is a better metric to use than LTV. Why? Because within 18 months, most young companies will have collected enough data about how long it takes to recover the cost of acquiring a customer, instead of waiting 2 or 3 years to observe LTV.

Benchmarks exist for public and private payback periods, and it doesn't require making assumptions about the distant future, an early stage business can evaluate its go-to-market strategy more quickly.

Tying marketing spend to LTV is a challenging prospect for early stage businesses because they are asked to make projections many years ahead with little historical data. Instead, use the payback period. The general benchmark for startups to recover CAC is 12 months or less. High performing SaaS companies have an average CAC payback period of 5-7 months.

How SMBs can use customer lifetime value?
Just calculating your customer lifetime value on its own doesn't provide much value as an overview of the profitability of a product or service, or your business.

As we've established, your customer lifetime value needs to be higher than all the expenses that occur in the purchase; otherwise, your business will be at a loss each time it makes a sale.

A metric that is useful and ties in with your customer lifetime value is your [customer acquisition cost](add link to CAC). Your customer acquisition cost is how much you've spent to acquire a new customer. It is calculated by taking your sales and marketing costs and dividing it by the total number of new customers you acquired. Although it won't impact your customer lifetime value, it gives you a better understanding of how this money is being spent in terms of marketing. For a young business, it is very common to spend up to 50% of its total budget on marketing, while in more mature companies, marketing accounts for around 10% of the total operating expenses.

A second metric is your attrition rate or churn rate, which refers to the total number of people (accounts, subscribers, members, customers) that have left in a given period. Understanding why a person has left gives you the opportunity to improve your product or service so that future customers will stay with you for longer. This, in turn, will improve your customer lifetime value.

Third, your retention rate, which is the opposite of your attrition rate. Your retention rate shows you how many customers stayed with you in a given period, rather than left. Your retention rate can teach you why a customer has decided to stay with you. It might be because of a feature that is really insignificant to the purpose of the product but has a huge impact on the customer. Understanding these reasons will help you optimize your sales funnel and marketing strategy, as the features you (the owner) might think are important may not be the same as those valued by the customer.

The Simple LTV Calculator for SMBs

To calculate your customer lifetime value:
  1. Enter average order value (last month)
  2. Multiply it by the number of sales customers will make in a given time period
  3. Multiply by Gross profit margin %
  4. Multiply it by overall retention time (the more the better)
Our sandals shop has an average order value of $65 which is made 4 times every year. The customer stays for a total of 2 years, until leaving.

Therefore, we (1) take $65, (2) multiply it by 50% gross profit margin, (3) multiply by 4 which gives us $130, lastly we (4) multiply this by the retention time of 2 years – $260.

$65 x 50% x 4 x 2 years = $260 customer lifetime value

The Simple LTV Calculator for SMBs
Period customer stays
Customer Lifetime Value:
Latest news