Customer Lifetime Value: What it is and How it Affects Your Bottom Line

Customer lifetime value is one of the most important metrics for every Shopify store. It’s a critical key performance indicator that helps you squeeze more performance out of your store. In this article, we’re going to explain customer lifetime value and how it’s calculated. We’ll also show you how to boost yours. 

What is Customer Lifetime Value (CLTV)?

Customer lifetime value is the amount of revenue a customer represents over the life of that relationship. In other words, it’s how much money a customer spends with your business from their first transaction to their last. 

This is an important metric that helps you understand the real value of a customer so you can make smart marketing decisions. Here’s what it tells you:

It tells you when a customer will become profitable

Like most businesses, you probably spend some money on marketing. These expenses reduce your margins and eat into your profits. If you are trying to keep your marketing expenses per customer lower than the value of their first order, you probably aren’t spending enough to trigger real growth. Understanding your customer lifetime value tells you exactly how much you can spend to capture a customer and when they become profitable. 

It tells you which segments deserve more investment

If you break your customer LTV into segments, you’ll notice they are quite different. Some customers are never profitable because their purchases don’t overcome your acquisition costs. Other customers become profitable and a minority of customers are very profitable. Knowing exactly how much they’re worth, you may decide to invest more in acquiring them. 

Image: Popupsmart

It tells you whether your customers are satisfied

You can run as many surveys, questionnaires, or Net Promoter Score tests as you like, but the best indication that your customers like your products is if they buy again. A high customer lifetime value means you’re doing something right. A low value means you have some work to do to encourage repeat sales. 

It helps you plan your marketing budget

“How much should I spend on my marketing?” is a question we hear a lot from Shopify store owners. Customer lifetime value can help you make this determination. 

For instance, let’s say you know that you earn $300 from a customer over their lifetime. You would want to keep your customer acquisition cost (how much it costs to acquire that customer) below $300. If it costs more than that, you’ll actually lose money every time you capture a customer.

Knowing your CLTV also lets you think beyond the first sale. If most customers purchase a second or third time, it might be worth losing a bit of money on the first sale to create a profound experience that drives future sales. This works at the product level, too. Sometimes it’s worth losing money on a product if it encourages people to buy other products.

How Do You Calculate Customer Lifetime Value?

Calculating customer lifetime value is a financial projection, so it relies on you to make some reasonable assumptions. For this reason, your CLTV will fluctuate over time. Here’s the equation:

Image: ProductPlan

Customer Lifetime Value = (Average value of a sale)*(The number of orders each year)*(The average length of the customer relationship in years)

To get the average sale value, you’ll need to divide your revenue by the total number of orders. The goal is to average out your orders so one number represents them all. Let’s say you have $125,000 in revenue and 1,230 orders. 

Average Sale Value = ($125,000/1,230) = $102

To get the average number of orders in a year, add up all of your transactions for the year (the total number of orders) and divide by the total number of customers. We already know you had 1,230 orders. Let’s say that came from 815 customers. 

Average Number of Orders Each Year = (1,230/675) = 1.8 transactions/year.

To get the average length of the customer relationship in years, we look at the sum of the time periods between first and final purchases for your customers, divided by the total number of customers. Let’s say the sum of years comes out to 2,150 years. We already know you had 675 customers. 

Average Customer Lifespan = (2,150/675) = 3.18 years. 

Let’s recap what we know. We know that on average, customers make 1.8 transactions per year totaling $102 for 3.18 years. 

Now we plug it into the customer lifetime value equation:

Customer lifetime value = ($102 * 1.8 * 3.18) = $583.85

We also recommend taking it one step further. You see, that customer lifetime value is your gross revenue from each customer. It doesn’t represent what goes into your pocket. For that, we have to multiply our customer lifetime value by your profit margin. Let’s say your average profit margin is 35%.

($583.85 * 0.35) = $204.35 profit per customer per year. 

That all said, we don’t recommend calculating just one lifetime value for your entire customer base. It’s smarter to divide your customers into reasonable segments. 

For instance, you might have wholesale and retail customers. Or you might separate your customers based on size or type of business. Calculating LTV for each segment will give you better information about how your customers make purchases. 

In some cases, it may also be helpful to calculate customer lifetime value for each customer. This would help you identify specific customers who are more valuable than others. You could reach out to them with unique deals, extra services, or special pricing. 

If all this calculating seems overwhelming, there are some Shopify apps that will help automate the process.  We recommend TrueProfit.

How Do You Increase Customer Lifetime Value?

In one survey, 91% of companies report that investment in boosting their customer lifetime value is more profitable than investment in customer acquisition. Most companies recognize that there’s simply more money to be made by selling to the same customers again and again. 

Improving your customer lifetime value is about forming positive, long-lasting connections with your customers so they feel comfortable purchasing again and again. There are three buttons you can push to increase customer lifetime value:

1. Increase the amount customers spend on each transaction
2. Increase the number of transactions in a year
3. Increase the number of years they purchase

Here are some actionable tips to push those buttons:

Increase your prices

Increasing your prices is an easy way to boost customer lifetime value, but you have to be careful. Instead of adding $5 to every product, run some careful price testing to make sure your prices are optimal. 

Make it easy for customers to process returns and refunds

These practices make customers feel comfortable buying from your store. If it’s hard to return an item, odds are slim they’ll make another purchase in the future. 

Set clear shipping expectations

Your customers want to know when they’ll receive their products. If they get their orders as promised, they will be more likely to order again. This is one area of your business where it's better to under-promise and over-deliver.

Here is an app that we recommend that will help with this.

Make it easy to contact you

Customers trust brands when they have an easy way to contact the business. Make yourself as accessible as possible to your customers, by phone, email, text, or live chat. If they send you a message, reply promptly.

Create a loyalty program that rewards repeat purchases

Loyalty programs create incentives for customers to purchase over and over. If they don’t make another purchase, they can’t redeem their loyalty points, which feels like losing something. Over time, this investment turns you into their go-to store. 

Increase order values with upsells and cross-sells

Upselling and cross-selling adds more products and/or higher value products to their order, thereby increasing the customer lifetime value. 

Stay in touch with regular email marketing

Email marketing (with Klaviyo or Omnisend) is a powerful way to bridge the gap between purchases. It lets you stay in contact, remind your customers why they like your store, and give them reasons to return. Regular, personalized email marketing is a key way to drive repeat purchases and extend the duration of your relationship with the customer.

Identify and reward your best customers

Look at customer lifetime value on a customer-by-customer basis. Identify the customers who are worth the most. Segment them into a group and design programs specifically to meet their needs. They have already shown that they are willing to spend with your business, so find ways to reward and incentivize them further. 

Close the loop with unhappy customers

If a customer is unhappy, don’t wash your hands of the situation and think, “Well, you can’t please everyone.” Find a way to make it right so everyone leaves happy. Proactively reach out to complainers and people who leave bad reviews to solve their issues. In many cases, targeted efforts actually make relationships stronger.

Consider the overall customer experience

The customer experience includes every interaction a shopper has with your store, from the moment they first learned about your brand, through their store visits and purchases, their use of the product, and even their exposure to your advertising and social media presence. Consider this entire process. Ask yourself if there are any ways to make it smoother. Can you eliminate friction anywhere?

Going Forward

By now you should understand how customer lifetime value works and why it deserves your attention. Focus on the strength of your relationships with your customers, even if it costs a little more today. If you think in terms of lifetimes instead of just the next sale, you’ll drive more revenue from the same customers.

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