Customer Lifetime Value Explained

Video Transcription

Today we explain single customer lifetime value, understanding how valuable each and every customer that comes into your business is. And it’s important because if you know the value of each customer, you know how much to spend to get customers.

Business Value and Likely Profit

And ultimately you can work out how valuable your business will be and what profit it’s likely to generate in future if you know how much a single customer is worth to you. Because I’m sure like us, you probably want to get more than one customer in your business.

So let’s look at the three ingredients that make up customer lifetime value.

Three Ingredients to Customer Lifetime Value

Ingredient number one is we need to understand our subscriber acquisition cost or customer acquisition cost.

Customer Acquisition Cost

People use those terms interchangeably. So we’re going to call that the SAC or the cost. We need to understand how much it will cost us to get the customer.

Revenue & Margin

The second thing we need to understand is the revenue and the margin that a single customer will deliver. And that will be the revenue and the margin over their lifetime.

Maybe you’re selling a subscription to something every year, 100 or 1000, whatever it might be. But we’ll need to understand the revenue, and what it costs to deliver that revenue for the customer.

So the margin, ultimately.

Customer Churn

The third thing that we need to understand is how long we’re going to have that customer. People call this the churn rate, which is often expressed as a percentage of customers, or revenue, that leave you over a period of time.

Typically expressed in annual terms, the churn percentage.

Once we know all of those things, we’ve got the raw ingredients then to calculate our customers lifetime value, so let’s do an example, shall we?

Example LTV

So, I will do an example of a relatively simple subscription business.

That per subscription business is going to cost 50. So we’re going to put 50 in brackets to get every customer. And that’s the cost of doing our online marketing and other activities to bring customers to us. We’ve already worked that out and it’s costing us about 50 to get each customer.

And each customer will deliver us an annual revenue, our annual subscription revenue of 100.

Now, we’re going to keep this simple, and we’re going to assume the margin is 100%. Just for the simplicity of this example. So we’ve got a hundred pounds of revenue, and it’s all, it’s all margin, all profit for us to keep in there.

And we’re going to assume the churn rate is we lose 20% of our customers each year.

So that means if you divide one by 20%, you get five years. So our average customer is going to stay with us for five years is what that churn rate means there. So we’ve got our customer acquisition cost of 50 pounds, our income of 100 pounds, and our lifetime of five years there.

So what is the customer lifetime value over here? Well, When you multiply this out,

We’ve got our 50 as a negative to start with, plus 100 times our five years. So our customer lifetime value is 450 in this example.

So, each customer is worth to us 450. Now why is that useful to understand?

Acquiring more customers

Well, it’s useful to understand how much headroom we’ve got. To acquire more customers. So if we spent, you know, a little bit more acquiring customers, how many could we acquire? How much flexibility have we got in our pricing and our margin? Can we put it up? Can we put it down? How can we change this 450 for the better?

So you can model out and look at how you can improve this customer’s lifetime value, and we’ll do that in another session. If you wanted to draw this over time, then the best way to look at that is to draw a little T chart here, and we’re going to have time on this axis, T, and money on this axis here.

And the interchange of these two axis is zero, so zero time, zero money.

And, I’m just going to put some, some numbers on here. So, we’ve got our 500, 50, 5 years. So, if we looked at this from a graph perspective and we wanted to understand where we were at any one point in time, over that single customer journey, we would start at our negative 50, because that’s what it costs to get a customer, and we’re going to end up at about 450.

Break Even Point

After five years, so somewhere around there. And in this instance, we will be generating a hundred pounds of revenue per year. So we’re going to look something like that. And the point at which your line crosses your zero pound line is something called the break-even point or the point at which you’ve got all your money back from acquiring customers.

And in this instance, it’s approximately six months for this customer. So our break-even point here is six months. And once we’ve had the customer for six months, we’ve earned enough revenue to pay back our initial customer acquisition costs. And we’ve gone the mulmary way to extract the 450 of lifetime value out of a customer.

So, that is the single customer lifetime value explained. Hopefully, that’s useful. And you can see how that all comes together to form a number. And that actually knowing the number can help you to improve your business metrics and improve your growth potential. See you next time.