Life Time Value (LTV)
Customer LTV represents the meeting of financial and marketing perspectives. Technically, LTV is defined as the sum of the stream of discounted, future cash flow generated by a customers business. Frequently though, the discounting concept is not applied. A common formula for LTV is:
(Avg Profit Per Order * Orders Per Year * Expected Customer Lifetime)
- (Annual Retention Cost * Expected Customer Lifetime)
- Aquistion Cost
And for Excel users out there, here is a simple .xls template for LTV analysis.
In his article “What’s Your Value“, published on TargetMarketing, Jack Scmid offers a great analysis of how to valuate your customer list as an asset for your overall firm pricing. It is particularly relevant to direct marketers.
One common problem organizations face calculating LTV is accumulating enough history. One way to combat this is to timebox the analysis away from lifetime to say a quarter, month, week, or whatever timeframe is needed to drive a period analysis.
Another benefit of limiting the time is that it aligns the frame of analysis with the financial and cash needs of the business. Most businesses today arne’t concerned with cash generated five years from now, they need payback in much more immediate fashion. In this way decisions to invest in customers can be evaluated for impact on current year financial performance.
Michele Eggers and Jeff Gilleland of SAS recommend a 5-step approach to rolling out LTV for firms new to customer metrics. Their article was published in Chief Marketer some time back, but is still sound advice.
1. Start with revenue. Figure out a sales / customer ratio
2. Add in expenses. Well… subtract actually to drive to profit / customer ratio
3. Set 3 year time frame. Look at expected contribution over 3 year period
4. Can you expand the customer view to the household.
- I liked their other points, but didn’t quite get this one. Households? HTV? Neilsen called and they want their 20th century metrics back!
5. Identify power up opportunities. Can you grow the value of your list by finding ways to drive more profit out of your house list.
