Once In A Lifetime

How to calculate lifetime value

There are two types of people in this world: those that love math and those that don’t. (This is actually slightly backed up by science). I happen to fall into the former as math has always come naturally. I remember working with my dad (who was a math major) for hours on various problems – both simple and complex. From an early age, I was taught how to calculate percentage discounts in my head. 

We're here to make it much simpler than this

However, not everyone has the same affection for algebra, trigonometry, and abacuses as I do. For them, calculating something like how much you can expect a customer to spend at your business (over a set period of time, not just once) can be daunting. Depending on how many layers you want to add, calculating the lifetime value (LTV) of a customer can be admittedly daunting. Depending on how many layers you want to put on the calculation, it can admittedly be daunting. However, it be a great tool as it can tell you how much to spend on customer acquisition, whether you should boost your retention efforts, or if your margins are too low. 

The Equation:
Average Sale * Number of Transactions * Time

The Explanation:

• Average Sale can be found by taking your total revenue and dividing it by the number of sales
• Number of transactions is also an average. Take your total orders and divide by the number of customers.
• Time can be tricky to calculate (particularly if you are new). If you can find your retention rate, you can extrapolate this out to get an average time. Or you may just have to estimate (see below).

Remember, you can make this calculation for any product, season / time (such as lunch vs. dinner), or customer segment served.

The Example:
A person goes to a salon to get a haircut every 3 months. They spend $30. They attend that salon for 3 years. 
Their LTV = 4*30*3 = $360 in total revenue.  

A couple of final thoughts:

• Make sure to always bring this back to your ROI. Use it when evaluating new marketing costs or promotional discounts
  
  
• You may have to differentiate between historic and prospective (for example, if you have a major market shift or a new product). You’ll know best when it comes to estimation, but a general guideline of 3 months for a new product and 1-3 years for established are good starting points. 
  
  
• Don’t forget to include add-on costs. If it costs you an additional $300 / month to service a customer, this could move you from the black to the red. 

Keep checking back for our next post! (No math guaranteed!)

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