Background: Why CLV is important?
The most important question we ask prospects during our introductory call is: what is your customer's lifetime value? And if they have a good answer, we go further with: do you have this segmented into customer cohorts?
This metric ultimately determines all paid advertising planning. We don’t know what an acceptable customer acquisition cost is until we have determined our client's total average customer lifetime value, as well as, the lifetime value of customer cohorts delineated by how frequently these cohorts purchase again, or churn, over a given time frame. Once this is clearly determined, we’re much better prepared to justify advertising spend on various channels as well as certain audiences.
We’ll explain why this is important. Starting first with the definition of customer lifetime value. Wharton Professor of Marketing, Peter Fader’s definition as defined by his book, Customer Centricity: Focus on the Right Customers for Strategic Advantage, is the best start:
“Can we look at what a customer has done in the past and make a pretty accurate projection of what they are likely to do in the future?
And it’s not only coming up with a single number, it’s breaking it down into how long will this customer maintain the relationship with us? How many more transactions will they have? What will be the size of those transactions? So it takes in a number of different predictive elements that, when you combine them all together, gives you CLV [Customer Lifetime Value].”
What does this analysis do for a business? Fundamentally, if your CLV is greater than your CAC, then you have a scalable acquisition channel. Applied to paid digital advertising, you can spend as much money available to acquire new customers as long as your CAC is lower than your CLV. So this becomes the most important metric to clearly define and track as you scale your acquisition channels.
LTV applied to businesses:
One important consideration is LTV is different based on the type of product or service delivered. Customer cohorts will differ and there will be different ways to understand net profit based on the type of product or service. This can be broken down into a couple of categories (listed below). To save time digging into every single business model, We’ve linked each business type to what we believe is the leading resource for understanding LTV:
- Consumer products
- SaaS subscriptions
- Services businesses
- Publisher subscriptions
- Nonprofit fundraising
General LTV analysis:
However, to still provide a general framework for LTV, we found Avinash Kaushik of Occam’s Razor provides the best step-by-step breakdown of LTV.
- Determine purchases per year and average order value per customer to get an average LTV for your business
- Segment customer base by total purchases over a year and their average order value to create customer cohorts based on LTV (can be as simple as above average, average, and below average)
- Determine Net Profit per customer segment to understand the true value of LTV
- Identify channels, campaigns, media, or propositions that deliver "better than average" customers so we can begin to see how much more profitable they are
- Select your lifetime (first look might just be a year, but if your business has been around for a while, it’s best to extend this as much as possible to get the most accurate view of LTV)
- Use the analysis above to determine the target CAC by channel and prospective audience (your most valuable customers are likely to have a much higher CAC, but you can be confident in paying this, knowing what value they bring over their lifetime).
1. You'll notice instantly that almost none of the data above is available in your web analytics tool.
2. Remember to focus not on the "Individual Customer", but rather focus on the acquisition channel by analyzing segments of customers.
3. You'll do most of this type of analysis via your ERP / customer data storage system / financial data warehouse.
4. Your analytics infrastructure is crucial to ensure the key meta-data required to do this analysis passes from your website to the sources mentioned above.
5. If you are a multi-channel company you'll want to ensure an equivalency exists in your backend system to track the same customer's multi-channel orders correctly and contains cost data from all multi-channel campaigns.
- Excellent Analytics Tip #17: Calculate Customer Lifetime Value: https://www.kaushik.net/avinash/analytics-tip-calculate-ltv-customer-lifetime-value/?
- The Most Important Business KPIs. (Spoiler: Not Conversion Rate!): https://www.kaushik.net/avinash/the-most-important-business-kpis/
- A brief intro to CLV: https://adamsinger.substack.com/p/a-brief-intro-to-clv?r=5ojp
- Peter Fader: https://knowledge.wharton.upenn.edu/article/160811b_kwradio_fader-mariychin-mp3-zodiac/
- E-commerce LTV: https://commonthreadco.com/blogs/coachs-corner/customer-lifetime-value-ecommerce
- Services businesses LTV: https://firstpagesage.com/seo-blog/marketing/average-customer-lifetime-value-ltv-clv-for-a-services-company-fc/
- SaaS LTV: https://amplitude.com/blog/saas-ltv#:~:text=SaaS%20LTV%2C%20or%20Software%2Das,time%20being%20with%20your%20company.
- Publisher LTV: https://www.inma.org/blogs/digital-subscriptions/post.cfm/subscription-marketing-3-ways-to-build-the-engine-to-drive-new-acquisition
- Donor LTV: https://www.keela.co/blog/nonprofit-resources/donor-lifetime-value