Are you looking to drive more sales and revenue for your ecommerce business? If so, then understanding and optimizing your customer lifetime value (LTV) is crucial. LTV is a valuable metric representing the total amount of money you expect a customer to spend on your business throughout their relationship with your company. By understanding and maximizing LTV, businesses can make informed decisions about marketing and customer retention and ultimately drive more revenue.

In this article, we will provide a step-by-step guide on how to calculate LTV for your ecommerce business. We will also provide tips on increasing LTV. By the end of this article, you will have a better understanding of LTV and how it can benefit your ecommerce business. So if you're ready to learn more, let's get started!

What is customer lifetime value?

Customer lifetime value (LTV) is a metric used by businesses to measure the financial value of a customer over their relationship with the company. This number is calculated by figuring out how much money a customer has spent with you over the whole time they have been a customer.

You can use LTV to compare the value of different customer cohorts, identifying which customers are most valuable to your business. Once you know which groups of customers have high lifetime value, you can target your marketing efforts at these individuals to drive more sales and revenue. To do this, analyze your customer data to identify common characteristics or behaviors of high-value customers and then target your marketing efforts at the identified segments. 

SMS is an excellent option for targeted marketing because it allows businesses to send individualized messages to customers.

The average LTV of all your customers helps you to figure out how healthy your business is. If your LTV is high, you are making a good profit from each customer you bring on board and are likely to see continued growth in your business. 

By understanding average lifetime value, you can also make informed decisions about prioritizing acquisition or retention. Let's say your average customer lifetime value is $100. If the cost of acquiring a new customer is a lot less than $100, then it might make sense to spend more money on marketing to bring in new customers. On the other hand, if acquiring a new customer is more expensive than your average customer lifetime value, then it might be better to focus on retention strategies for existing customers instead.

How to calculate customer lifetime value

To calculate how much the average customer spends with your brand during their relationship with you, you first need to figure out the following:

  • how much money they spend on average per purchase (average order value, AOV)

  • how often they make purchases (average purchase frequency rate)

  • how long they stay a customer (average customer lifespan)

1) Calculate AOV

The average order value (AOV) is a metric that represents the average amount of money spent per purchase. To calculate the AOV for a business, use the following formula:

AOV = Total Revenue / Number of Orders

For example, if a business had total revenue of $100,000 and received 1,000 orders over a given period of time, the AOV would be $100 ($100,000 / 1,000 = $100).

2) Calculate the average purchase frequency

Purchase frequency is a measure of how often customers make purchases from an ecommerce business. To calculate the purchase frequency, use the following formula:

Purchase Frequency = Total Number of Orders / Number of Unique Customers

For example, if an ecommerce business received 1,000 orders from 500 unique customers over a given period of time (let's say over a year), the purchase frequency would be 2 (1,000 / 500 = 2). That means people buy, on average, twice a year. 

3) Calculate the average customer lifespan

The average customer lifespan is a measure of how long customers remain active or engaged with an ecommerce business. It's more difficult for ecommerce businesses to calculate their average customer lifespan than, say, a software business with a subscription model — because people might make infrequent or spaced-out purchases but maintain their relationship with you. 

You have to define who your 'active' customers are. For instance, if customers typically buy from you monthly, you might decide that customers who haven't made an order in six months are no longer 'active,' and from there, you can calculate how long they retained as a customer. If people typically buy from you on a less regular basis, you might wait for longer before considering that someone is no longer a customer.

4) Use this customer lifetime value calculation

Here's the formula for calculating CLV: 

customer lifetime value = aov purchase frequency customer lifespan

Let's say that your ecommerce business sells clothing and accessories, and you have collected data on the purchasing behavior of your customers over the past year. You have determined that the average order value for your business is $80, the average purchase frequency is two times per year, and the average customer lifespan is three years. Using this information, we can calculate the CLV of your customers as follows:

CLV = $80 2 purchases/year 3 years = $480

This means that the average customer of your ecommerce business is expected to spend $480 over the course of their relationship with you.

LTV vs. customer acquisition cost

The difference between lifetime value (LTV) and customer acquisition cost (CAC) is that LTV represents the total amount of money that a customer is expected to spend on a business over the course of their relationship with the business, while CAC represents the cost of acquiring a new customer. By understanding both metrics, ecommerce businesses can make informed decisions about marketing and customer retention.

The ratio between LTV and CAC can be used to determine the maximum amount that a business is willing to spend to acquire a new customer. To calculate the ratio, divide LTV by CAC. For example, if your average LTV is $200, and your customer acquisition costs per customer total only $20, then your ratio is 10:1. 

Best practices to increase LTV

Increasing LTV benefits ecommerce brands because it allows them to generate more revenue from their existing customer base, making their business more efficient. To increase customer lifetime value, ecommerce brands can use various strategies to increase the number of loyal customers they have and to encourage people to spend more per order. They can, for example:

  • Create loyalty programs

  • Offer discounts and promotions

  • Use data-driven marketing

  • Provide a user-friendly shopping experience

  • Upsell and cross-sell to increase the average purchase value

  • Invest in customer service

Read more in our post 7 Strategies For Improving Ecommerce LTV

LTV: one piece of the puzzle

While customer lifetime value (LTV) is an important metric for ecommerce brands, it is not the only metric that they should track. In order to make data-backed decisions that are informed and accurate, ecommerce brands need to consider a range of metrics and factors. Discover The 12 Ecommerce Metrics You Should Be Tracking.