The simplest way to calculate LVT is to multiply the average spend per visit by the number of visits per puchase cycle and then by the predicted number of cycles the customer will repeat.
Let’s use a simple example. A fast-food restaurant has a menu where all the products are a similar price and most customers order one meal per person. The basic variables you need are:
- Average customer expenditure per visit or order (o).
- Length of purchase cycle (c) e.g. day, week, month, year
- Number of visits or orders per purchase cycle (n)
- Average spend per customer per cycle (o x n) (v)
Basic LVT Calculation
Let’s say that our fast-food lunch meal deal means that o= $10. The customers are from the local factory and on average the customers visit 4 times a week so n=4. v=o x n, so v=$40
In order to calculate the CLV, you need to understand your average customer lifetime (t). Let’s imagine that in our example the employment contracts last 12 months. They get 4 weeks holiday a year so, so in this context t=52-4 purchase cycles.
In the simplest example, LVT = v x t or $1920.
Taking LVT to the Next Level.
Of course averages can be dangerous, and revenue is not really the financial metric that should be optimised. In order to understand the true value of a customer there are other variables that should be taken into account. These can include:
- Customer Retention Rate (r) : the percentage of customers who come back after the previous visit. The opposite of this would be the churn rate, the percentage customers who do not repeat purchase. This is why loyalty programs exist.
- Average Gross Margin per customer lifespan (m) or Profit per customer (p) : revenue is not everything. Business 101 says if you sell $100 worth of products but it costs you $110 then that’s not a sustainable model.
- Net Present Value or discount factor (f) : for the finance geeks, this one is to take account of the value of money today versus the value of money in the future. This is important if your customer lifetime is 20 years!
Let’s return to our local cafe. Let’s imagine for the sake of argument that the profit margin per customer (p) is 20%. Over the lifetime of the customer, the average margin per customer (m) would be $384.
To put it all together, let’s assume a discount rate (f) of 10% and a retention rate (r) of 90% (It’s a captive market). Our formula might look like this m(r/1+i-r) or 384 x (0.9/1+0.1-0.9) = $1728. Slightly lower than the simple equation.
But Why Bother?
Surely one of the advantages of Ecommerce even with entry level systems like Shopify is to use the digital metrics to calculate lifetime value for different customers and identify those who are customers you want to keep and maybe see if there are some that you don’t mind losing.