How to Calculate Lifetime Customer Value

|  June 1, 2004   |  Comments

Yes, you can calculate lifetime customer value! These no-more-excuses tips make the process as painless as possible.

In "What Should You Spend to Acquire a Customer?" I argued calculating the lifetime value (LTV) of a customer is the usual method for making such a determination and offered some quick alternatives for those who don't feel calculating LTV is a viable option.

My inbox immediately filled with requests for more information. It's no wonder. Calculating LTV can be a conundrum. The calculation itself is quite simple. But each step in the process is fraught with challenges and presents opportunities for doubt and debate. So we give up and move on to easier problems.

Let's look at this as if the glass is half full. Someday, you'll have everything you need to make calculating LTV easy and accurate. In the meantime, you need practice. If you wait for perfection, you won't recognize it when it finally arrives. So get started!

Lack of Data

A frequent stumbling block is lack of data. Your company has been in business for 10 years, but the first 5 years of records are on paper or stored in an old accounting system. You can't calculate LTV because you're missing half the data for your best customers and your number will be understated.

Well, hard-to-reach records aren't "missing" in my book. Perhaps my next endeavor should be a reality TV show in which a handful of today's marketers are left stranded in an '80s-era company and challenged to increase revenue using only paper-based customer records and Lotus 1-2-3. But I digress. The do-it-yourself method isn't popular with busy marketers, as evidenced by the feedback I received from "Beg. Borrow. Steal. Whine. Cajole. Learn SQL?"

Let's consider another option. This is just practice, right? If you have only five years of electronic data and aren't willing to dig for the earlier numbers, start as of five years ago and work your way through the calculation anyway. You can refine from there. Along the way, you'll probably realize you're better off data-wise than you thought you were.

Lost Customers

Another stumbling block: difficulty determining which customers are dead. In "How Are You Measuring Customers?" Bryan Eisenberg writes some marketers are unwilling to admit a customer is truly lost. If this is your problem, get over it! Just because you count a customer life as over for calculation purposes doesn't mean you can't market to that customer in the future.

New Company

A more legitimate issue: Your company has been in business for three months. Who can predict the future? How on earth can you know how long a customer will stay with you? You can't calculate LTV because you have no idea what a customer's lifetime will be.

Remember, today our glass is half full. Your fledgling company has the advantage of starting early in the LTV game. Again I say, Start practicing. What industry trends can you identify that indicate purchase size, retention statistics, or customer lifetime? What assumptions can you make now for the sake of practice? Your number will be less reliable (Bryan blames overestimating LTV as a dot-bomb factor), but the calculation process will keep you focused and set the stage for increased accuracy every month.

If your company is young and the future hard to predict, start the LTV calculation anyway. Simply use caution and common sense before making any business decisions. Try your calculation using different lifetimes, and refine your numbers every month, quarter, or year. Compare your assumptions to actual results. Compare your more conservative estimates (lower LTV) to your more aggressive estimates, and compare both to acquisition costs. Think of the advantage you'll have if you start now and build on your experience.

Choosing a Formula

Finally, there's the difficulty in choosing a formula. There's debate every step of the way. Do you include the value of referrals in your calculation? Do you stop at revenue or go all the way to profit? Do you segment customer groups or calculate one overall number for the company?

Why debate all this before even beginning the process? How can you take a stance without first calculating LTV to the best of your abilities? Get started! Debate the finer points later. Use more than one formula until you feel comfortable making a choice.

To make things as easy as possible, I leave you with a link to a very detailed calculator that includes a downloadable Excel spreadsheet. Take a stab at calculating the lifetime value of your customers. If you're not ready to rely on the number, treat the exercise as much-needed practice. But don't be surprised if you find your way out of the practice environment and into the real world of lifetime customer value.

Melaney Smith is a freelance marketer with more than ten years of experience in marketing, finance, and data mining. She evangelizes the need for businesses to mine their data and make it easily accessible for decision makers. She specializes in helping businesses utilize customer, transaction, and other data to improve or create sales and marketing programs.

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