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Mastering your Customer Lifetime Value

Mastering your Customer Lifetime Value

This is part 1 of a 5 part series on Consumer Lifetime Value.

One of the most critical metrics you can track for your business is the Lifetime Value (LTV) of your customers. This is the total amount of revenue you can expect to generate from a typical customer over the entire length of their engagement with your business.

LTV is a critical metric to track, since it informs how much you can afford to spend to acquire new customers (customer acquisition cost). If your LTV is $50 and it costs you $75 to acquire each new customer, then you are losing $25 with every customer! On the other hand, if your LTV is $50 and it costs you $5 to acquire each new customer, then you are getting a 10x return on that customer acquisition spend (and you have the flexibility to spend a lot more).

In modern marketing, companies who have a better measurement of LTV have a competitive advantage. For example, if you are sure that your LTV is $50, then you can spend up to $49.99 to acquire each new customer and still turn a (small) profit. If your competition isn’t really sure about their LTV but they think it is $50, they likely won’t be willing to risk spending $49.99 since they might be wrong and lose money. This means you can spend more to acquire customers even though your business might be identical!

LTV is a metric common to all businesses, but it is defined differently depending on your business model. Here are some examples:

  • For subscription businesses: Your LTV is the subscription price times the average number of months a subscriber is active.
  • For retail or e-commerce businesses: Your LTV is the total amount a given customer has ever spent in your store or on your website.
  • For advertising: Your LTV is the total number of impressions a user views times your typical revenue per impression (typically measured in revenue per  thousands of impressions).

There are many challenges in computing and tracking your LTV, some of which we will cover this week.

By the end of the week, my hope is that you understand your LTV so well that you can wield it as a competitive weapon!

“Life is what happens to you while you’re busy making other plans.” 
– John Lennon, in “Beautiful Boy (Darling Boy)”

Customer Lifetime Value: How to calculate LTV

This is part 2 of a 5 part series on Consumer Lifetime Value.

The hardest part of calculating your Lifetime Value metric is often determining the length of the customer lifetime. It doesn’t seem so at first, as intuitively it should be as easy as measuring the difference between when a customer is acquired and when they are lost.

Unfortunately, rarely do customers let you know when you’ve lost them! It’s very common that customers will go away quietly and you will not know if they will come back or not.

It can be hard to tell the difference between customers who have gone quiet and customers who are lost. But, have no fear, we will cover two ways to do just that: windowing and last action.

Option 1: Windowing

In this approach, you choose a set period of time (window) after which you will conclude a quiet customer is lost. Each time a customer interacts, the window is reset to start at the time of the most recent interaction. The size of your window will depend on your business; a supermarket might use a window of a few weeks (people buy food every week) but a ski resort might use a window of a year (since you can only ski during the winter).

Choosing the right window is critical for this approach, because if your window is too long it will take too long to realize you have lost a customer. Likewise, if your window is too short you will consider customers lost who were really just quiet and coming back on their own.

This brings up an obvious question: what do you do if a customer returns after your window is over? You have a few options but the best is to simply count them as a new user (again).

That is not as bad as it sounds. If your window is long enough, say 6 months, your product may be so different that the returning customer really is approaching it fresh. It’s also possible that what brought the customer back was something entirely different than why they were a customer in the first place.

Let’s break down the pros and cons of this approach.

Pros: It is very easy to calculate and is flexible because you can choose and adjust your window.

Cons: Your choice of a window is critical to success. If your window is too long it make take too long to realize you’ve lost a customer!

Option 2: Last Touch

A more aggressive approach, which works particularly well for products that have daily interactions with customers, like video games,  is to assume you have lost the customer after every interaction (touch) they have with your product, but if they interact with your product again, then you update your assumption and extend their lifetime.

As time goes on, and the customer interacts with your product, their customer lifetime grows.

Obviously, this means that there are cohorts of customers who will have artificially short customer lifetimes. If a customer joined a week ago, they cannot have interacted with your product for a month! For this reason you need to be careful in considering which cohorts you use when calculating your lifetime.

Let’s break down the pros and cons of this approach.

Pros: You know immediately which customers you need to focus on bringing back.

Cons: It is difficult to calculate and overly pessimistic when measuring lost customers.

This is a complex topic so I recorded a short video (5:00) that might be easier to understand. There are many other techniques you can use, and hopefully this has gotten you thinking about the best method to use for your business.

Tomorrow we’ll dive into how to get started with calculating your LTV.

“It took me four years to paint like Raphael, but a lifetime to paint like a child.”

Customer Lifetime Value: Three ways to estimate your LTV

This is part 3 of a 5 part series on Consumer Lifetime Value.

I hope it’s clear why knowing your customer Lifetime Value (LTV) is important, and a potential competitive advantage. However, when you first launch a new product, service or business, you haven’t had customers for very long! How do you estimate your LTV in those early days?

That’s a good question! There are a number of techniques for estimating your LTV even when you are first getting started:

  • Build a modelWhen you decided to pursue your new product or service, you did research to make sure it could be a profitable business. Hidden in that model is a LTV estimation in the form of the number of customers you plan to retain and how much they will purchase. Extract that LTV from your model and start with that as an estimate.
  • Use Industry Benchmarks. While you might not know your customer LTV yet, other companies similar to yours have comparable LTVs that you can use. For example, some firms publish an annual report that includes average LTVs for e-commerce services. Be sure to adjust benchmarks for your business by examining the assumptions!
  • Be Conservative. While you don’t know how much a user will be worth over their lifetime, you can segment customers by their initial purchases and in doing so estimate their future LTV based on similar customers. When doing so, be conservative when assigning a customer to a segment so that you will never over-estimate LTVs.

There is no replacement for having real data, so all of these only provide you with an estimate that you will adjust as you gather data of your own. Be sure to revisit your LTV estimate on a regular basis as even small changes might radically affect your customer acquisition strategy!

Our estimates vary with our moods; the time may be much longer than our hopes and much shorter than our fears.” 

Customer Lifetime Value: Three examples

This is part 4 of a 5 part series on Consumer Lifetime Value.

A Tale of 3 Lifetimes (Values)…

We have theorized about customer Lifetime Value (LTV) so far this week, but now it’s time for some examples! Let’s talk about how different kinds of businesses calculate their LTV and the hidden traps that make it more difficult than it seems.

Retail / E-Commerce

For a retail or e-commerce business, the easiest way to compute LTV is to add up all the purchases a customer makes in your store or on your site. Credit cards make this very easy to do since they include a lot of information you can use to identify customers across transactions!

Wait, what’s the catch? Rate of returns. If you don’t take the rate of returns into account you will overestimate your LTV since some of those purchases will be reversed. Luckily, this is easy to handle. If your rate of returns is 5%, you simply discount your LTV by 5%.

Content (Advertising)

When you make most of your money from online advertising, it is harder to calculate LTV since it’s hard to know exactly how many (and which) ads a specific user sees. Instead, you can take the number of ad impressions per user session, multiply it by the number of user sessions in their lifetime and multiply that by the value per impression (typically the eCPM, which is the cost per 1,000 impressions). This gives you an estimate of LTV based on averages across those three vectors.

Wait, what’s the catch? Changing eCPMs. The revenue from ad impressions change constantly so your eCPMs are rarely constant for the entire lifetime of a customer. You need to either determine an average eCPM over the customer lifetime or compute the LTV for different segments of the customer’s lifetime separately.

Subscription (SaaS)

Subscription businesses are, in theory, the easiest to calculate LTV. You simply multiply the amount the customer pays per month of the subscription (cost) by the number of months in the customer life time. Simple, right?

Wait, what’s the catch? Upselling. If you have different subscription tiers and customers move between them over the course of their lifetime, their value is changing. You can either calculate blended revenue per month across the tiers or compute the lifetime value of customers on each tier separately.

I hope that makes it more concrete for you! If your business is not in one of the above verticals and you need help calculating your LTV just drop me a line.

Tomorrow we tackle the last topic in our exploration of LTV: How do you handle the fact that your LTV changes all the time?

“What’s the catch?”
– Attributed to PT Barnum in 1855, although there is no evidence he uttered this particular phrase. Prior to that, “catch” only referred to fishing.

Customer Lifetime Value: Handling Changing LTVs

This is part 5 of a 5 part series on Consumer Lifetime Value.

As with life, change is a constant with your customers. Especially when your business is growing, everything about your customers will change, including the revenue they generate, how long they stick with you and what they need from your business.

For all of these reasons, your customer Lifetime Value (LTV) will change over time as well. Sometimes it changes every year, but often it changes more frequently and when you least expect it. A sudden drop in LTV can be a big hit to your business if your customer acquisition costs are not adjusted quickly! You can go from paying $100 to acquire customers worth $200 to paying the same amount to acquire customers worth $50 overnight.

So, how do you handle constantly changing LTV and stay on top of any sudden changes? Here are some techniques:

  • Cohorting. Instead of tracking one LTV for all of your customers, track the LTV of customers by the month they first became a customer. This allows you to tell if customers from February are worth the same amount as customers from January. You can use daily, weekly or monthly cohorts depending on your type of business.
  • Make auditing a habit. Never assume your LTV calculation is correct just because it was last month. Just like all of your important metrics, you should revisit it on a frequent basis to make sure it is both correct and representative of your business.
  • Watch for early indicators. There are many indicators that your LTV is changing quickly, including price drops, jumps in customer churn or even shifts in customer engagement. If you identify a few early indicators then you’ll know when it’s worth revisiting your LTV assumptions.

It may not be possible to catch a change in LTV immediately, as it may take weeks or months to understand fundamental changes in customer engagement. Staying vigilant is your best defense, so watch out!

Also, always wear your seat belt. That’s generally good advice.

“The only constant in life is change” 
– Origin Unknown

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