What is Lifetime Value (LTV)?
The lifetime value of your customers is the total amount an average customer will spend with your business from their first to their last purchase with you. If your customers purchase from your business more than once, their value to your business will exceed the value of their first purchase.
The aim of your business is therefore to make the total value of their ongoing purchases as high as possible by making them want to keep coming back. The best part of being a practitioner is the relationships you develop with your clients, and seeing real improvement in their lives.
I like to think of LTV not just as a monetary value, but how much a practitioner is able to continuously help their clients.
Why is LTV important for your business?
Understanding the lifetime value of your customers is important for two reasons:
- Once you ascertain the lifetime value of your customer base, you will have a better insight as to how much you can and should spend on marketing campaigns to attract new customers to your business. You will be surprised to find out that you can justify spending more money to attract clients once you have ascertained the overall returns that you are receiving per customer over their lifetime. Once you determine what a customer is "worth" to your business, and how many clients you can take, you will be at an advantage.
- Another reason it is good to understand the lifetime value of your clients is to ensure that your business has quantifiable goals. In other words, you will be armed with the information you need to make accurate forecasts and budgets for your business (not the most exciting stuff, I know, but incredibly important!).
How to calculate LTV
Here are the steps in determining the lifetime value of your customers. You should note that, while we are determining an average, you might want to determine different figures for different groups of customers.
Step 1: Estimate how much an average customer will spend with your business per visit.
Step 2: Determine the cost of servicing this average customer, or the cost of goods sold.
Step 3: Subtract the cost of servicing this customer in step 2 from the amount of revenue received in step 1. This will give you the profit generated from an average customer per visit.
Step 4: Multiply the profit generated per visit by the number of visits per year from an average customer to your business. This will give you the amount of profit that an average customer contributes to your business each year.
Step 5: Now estimate the number of years that an average customer would continue to visit your business. You should then multiply this number by the amount of profit an average customer contributes per year.
The above calculation will give you an estimate of the direct lifetime value of your average customer. This estimate can be taken further when you consider the referrals, and therefore the extra profit, that a customer will bring you (see the next few steps). Adding the direct and referral values will give you the total lifetime value of an average customer.
Step 6: In this step, you need to estimate the number of new customers that an average customer will refer to your business.
Step 7: Now you should multiply the number of referrals by the lifetime value of your average customer, found from step 5.
Step 8: All that is left to do is to add your answer from step 7 with step 5 to give you the total lifetime value of an average customer.
It is perfectly fine to estimate the amounts used in the calculations of the lifetime value of your customers when you do not have any information to base it on. However, you need to start collecting information regarding these particular areas; it is from gathering this information that you will be able to gain an accurate measure of the value of a customer. This information will be invaluable in giving you a more accurate idea of your financial position and performance.
How to use LTV
Understanding the lifetime value of your customers is extremely important to the financial viability of your business. Once you understand this concept, not only do you have an accurate understanding of what a customer is worth to your business, and therefore how much you can spend to attract new customers, but you also gain an insight into how you can increase what a customer is worth to your business.
From the information gained through the analysis of the lifetime value of your customers, you can focus on four factors to maximise the lifetime value of your customers:
- Increase the length of time a customer is associated with your business, and, subsequently, the length of time a customer buys from you.
- Increase the frequency that your customers visit your business.
- Increase the amount they spend on each visit or purchase.
- Increase the number of referrals each customer brings to you.
Money aside, this is about being able to focus on why you got into this industry - to help people. If you’re happy with the amount of clients you currently have, focus on developing these relationships to keep them coming back - the power of returning clients cannot be overstated.