What are Your Customers Really Worth? Calculating Lifetime Value

If you want to run a profitable online marketing campaign, you need to to know what the lifetime value of your customers is.

After all, let’s face it, advertising online can be tricky. For some companies, it can be their top revenue source—for others it can be like throwing cash out of an airplane.

The question is, how do you know if your campaigns are actually making money? Sure, it’s nice if you can turn an immediate profit off of your ad spend, but not every company sees a day one return-on-ad-spend.

The answer, of course, is to calculate your customer lifetime value (LTV).

Calculating Customer Lifetime Value

In marketing, customer lifetime value is defined as a prediction of the net value (typically revenue) attributed to the entire relationship with a customer.

So, if T= average monthly transactions, AOV = average order value and ALT = average customer lifespan (in months), then:

Customer LTV = [T] x [AOV] x [LT]

There are other models out there that are more complex and can be more accurate, but this quick and dirty calculation will give you a good feel for your customer LTV and the profitability of your online marketing campaigns.

For more information about using your customer LTV to assess the effectiveness of your online marketing campaigns, check out this article:

BONUS: Does Your PPC Contribution Margin Justify Your Ad Spend?

Why Your Customer LTV Matters

In many industries, it can difficult to drive a first purchase profit from digital marketing.

Unlike conventional advertising, in digital advertising you typically pay-per-click. With a billboard, you pay a fixed amount regardless of how many people see your sign. With PPC advertising, the more people that click on your ad, the more you pay.

However, because every interaction with your ads happens online—where everything can be tracked—you know exactly which ads, campaigns, keywords and clicks produced which conversions and sales.

As a result, it’s fairly easy to figure out whether or not your ad spend is producing value for your business using your customer LTV.

To show you how all this fits together, let’s take a look at some statistics from a small business client of mine.

2015 Lead Statistics

• Total Costs = $18,465
• Total Leads = 511
• Closed Leads = 46
• Cost per Closed Lead = $401.41

Okay, not too much to see here. The client spent $18,465 and produced 46 closed leads (sales). That means they spent $401.41 on each sale.

Doesn’t look to shabby, right?

2015 Revenue Statistics

• Total Revenue from Closed Leads = $12,323
• Avg. Monthly Revenue per Closed Lead= $149
• Commissions Paid to Sales = $2,465

Yikes, now we have a problem. The client spent $18,465 on PPC advertising, but they only made $12,323 off of leads closed in 2015.

That means they are $6,142 in the hole!

But wait, it gets worse. They also paid $2,465 in sales commissions to close those leads. So, they’re actually $8,607 in the whole.

A lot of companies would look at this and say, “We spent $18,465 and—after paying sales commissions—we only made $9,858. Clearly, this isn’t working.”

However, this company is thrilled with their results.

Why? Well, because they understand their customer lifetime value, they know something that you don’t know: their average customer pays them $149 a month for seven years.

Determining the LTV

Let’s plug their data into our handy lifetime value formula and see what sort of revenue this client can expect from their PPC advertising efforts once we take their customer LTV into account.

• T = 1 transaction/month
• AOV = $149/transaction
• ALT = 84 months

Remember, customer lifetime value = [T] x [AOV] x [LT], so our equation looks like this:

Customer LTV = [T] x [AOV] x [LT]
Customer LTV = [1 transaction/month] x [$149/transaction] x [84 months]
Customer LTV = $12,516

So, each new customer is worth more than the company made off of PPC advertising in 2015.

Since PPC produced 46 new customers in 2015, let’s see how much revenue they stand to make from their PPC ads:

[46 closed leads] x [$12,516/closed lead] = $575,736

$575,736? For an $18,465 investment in advertising and $2,465 in sales commissions, that’s not a bad return…

Now, of course, this isn’t just $554,806 of straight profit, there are fixed and variable costs to taking care of those new clients that eat up a lot of that revenue.

However, for every $1 this client spends on PPC advertising, they are producing $31 in revenue.

With their advertising campaigns delivering at a 31X multiple, there’s a reason PPC makes sense for this client.

Using Your Customer Lifetime Value

One you know your customer lifetime value, you can use it to figure out where your business needs to improve to become more profitable.

For example, if my client’s average customer only lasted 3 years but the industry average was 8 years, they could focus on improving their customer lifespan.

Similarly, on the advertising side of things, if a particular campaign delivers customers that only last 3 months instead of 7 years, that campaign is probably delivering the wrong sort of traffic.

Overall, your customer lifetime value is an incredibly important way to assess the effectiveness of your online advertising. Sometimes, what looks on the surface like a money pit could actually be a gold mine.

By the way, if you’d like me to take a look at your marketing results and help you calculate your customer LTV, let me know here or in the comments. I’d love to help!

How do you use customer lifetime value to evaluate your online advertising performance? Do you have any favorite LTV equations?