What is LTV?
LTV (Lifetime Value) or CLTV (Customer Lifetime Value) – is the total profit received from a client during all the time while he/she is using the service.
Simplified example of LTV calculation:
- Cool Master Degree Program is free;
- The only cost of Cool Polish University is marketing to attract new students;
- The only profit from students – their fails on exams;
- Fail fee is PLN 610.
Some Cool Master Degree Program of some Cool Polish University lasts 2 years. The program is free, however if you do not pass an exam, you will have to pay PLN 610. So, if during these 2 years of free studies you will not pass 2 exams, you will have to pay PLN 1220. PLN 1220 is your LTV for Cool Polish University i.e. total profit received by Cool Polish University from you during all the time of your free Cool Master Degree Program.
Why is it important to know the LTV and CAC (Customer Acquisition Cost)?
LTV – is one of the most important metrics in the business (especially e-commerce) even if your business is registered as non-profit organisation. The majority of companies die because of the fact that the cost of attracting of a new customer (CAC) “outweighs” the lifetime value of the customer (LTV). Most such situations happen due to the fact that entrepreneurs are focusing on the transaction and often forget about the experience that the customer receives after conversion achieved (retention rate).
Simplified example of CAC and LTV calculation:
Assumptions: the same as in first case.
The marketing department of some Cool Polish University spends certain funds on marketing to attract new students. Let’s assume that marketing department spends PLN 200 on average to attract new student. This is our CAC. Let’s assume that 20 students were admitted to Cool Master Degree Program. So, the total budget spent to attract new student is PLN 4000 – total CAC. The question is how many students have to fail the exam during the 2 years’ master program to cover these costs? It’s simple. 4000/610. So, approximately 6 fails will cover costs for marketing of Cool Polish University. Of course the example above is extremely simplified. But the main idea here is to understand that LTV has to be higher than the CAC. Otherwise the business model is going to fail like these students on exams 🙂
Why LTV is so important?
LTV can help you:
- Identify the ROI (focus exactly on the channels that will bring you the best customers).
- Improve customer retention strategy.
- Increase effectiveness of communication with the customers.
- Improve behavioral triggers (understand why your customers pay you).
- Improve productivity of customer support.
- Focus your time on the special attention to the most valuable customers.
In my next post I will give you several approaches to calculate LTV and they will be more complicated.
Names, places and incidents either are products of the author’s imagination or are used fictitiously.