Guide · Marketing
Customer Lifetime Value: How to Work It Out With Simple Math
Customer lifetime value is the total revenue one customer brings you over the whole time they buy from you. You find it by multiplying three numbers: average purchase value, purchase frequency and customer lifespan. This guide shows the formula, a worked example and how to use the answer to set ad spend.
What it means
It is the total money one customer brings your business over the whole time they buy from you. It looks past the first sale and asks what a customer is worth in the long run.
That changes how you judge ads. A customer who spends little at first may come back many times. One big first order may never be repeated. Counting only the first sale hides this.
You will also see it written as CLV, CLTV or LTV. They all mean the same idea.
Sources: Shopify, How To Calculate Customer Lifetime Value; HubSpot, How to Calculate Customer Lifetime Value
The simple formula
The common formula has three parts. You multiply them together.
- Average purchase value: total revenue divided by the number of orders in a period.
- Purchase frequency: the number of orders divided by the number of different customers in that period.
- Average customer lifespan: how long a customer keeps buying before they stop for good.
First multiply the first two. That gives you customer value for one period. Then multiply by the lifespan. In short: customer lifetime value = average purchase value x purchase frequency x average customer lifespan.
Lifespan is the hardest part. A shop with a sign-up contract knows when customers leave. An online shop does not, because a buyer can simply stop coming back. For those shops, you usually estimate lifespan from past order data.
Sources: Shopify, How To Calculate Customer Lifetime Value; HubSpot, How to Calculate Customer Lifetime Value
A worked example with round numbers
These numbers are made up. They are an example only, not a benchmark. Say a small online coffee shop had 2,000 orders last year from 500 different customers. Total revenue was $60,000.
Step Working Result Average purchase value $60,000 divided by 2,000 orders $30 Purchase frequency 2,000 orders divided by 500 customers 4 orders a year Customer value per year $30 x 4 $120 Average lifespan Estimated from past data 3 years Customer lifetime value $120 x 3 $360 So in this example, one average customer is worth about $360 in revenue. That figure is revenue, not profit. Your costs to make and ship the goods come out of it. A careful owner will repeat the math with gross profit in place of revenue, to see what is really left.
How it guides ad spend
Once you know the number, you can set a ceiling for what to pay to win a new customer. This cost is called customer acquisition cost, or CAC.
In the example, a customer is worth $360 in revenue. If it costs $400 in ads to win one customer, the business loses money. If it costs $50, the business has room to spare.
Shopify says a good ratio of lifetime value to acquisition cost is 3 to 1. Treat that as a rule of thumb, not a law. Your margins, cash and market may call for a different target.
HubSpot notes that acquisition cost is not part of most lifetime value formulas, but that comparing the two helps you judge how well marketing and sales work. It also helps you decide where to put your budget.
This is useful when you hire an agency. Ask them to report cost per new customer, not only clicks or leads. Then compare that cost to your lifetime value.
Sources: Shopify, How To Calculate Customer Lifetime Value; HubSpot, How to Calculate Customer Lifetime Value
Ways to raise the number
Because the formula has three parts, you can lift any one of them.
- Raise purchase value. Offer bundles or related items at checkout.
- Raise purchase frequency. Send useful follow-up emails and reminders to reorder.
- Extend lifespan. Fix problems fast, and keep in touch so customers stay.
HubSpot points out that keeping a customer is usually cheaper than winning a new one. That is a good reason to look at lifespan first.
Limits to keep in mind
The simple formula uses averages. Averages can hide a lot. A few big spenders can pull the number up and make a typical customer look better than they are.
It also looks backward. It assumes the next customers will act like past ones. If your prices, products or ad channels change, the numbers may change too.
The easy fix is to work it out for groups. Split customers by how they found you, such as search, social or email. Then compare each group's value. Treat the results as a guide, and update them each year.
Sources: Shopify, How To Calculate Customer Lifetime Value; HubSpot, How to Calculate Customer Lifetime Value
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