1. Introduction to LTV
Welcome back! In this chapter, we'll be talking about the LTV/CAC ratio used widely across marketing today to measure ROI, return on investment.
2. LTV
LTV stands for “Lifetime Value”
It is represented of how much a customer is worth to the company over the customer’s lifetime. You may also hear it referred to as CLTV, customer lifetime value.
The lifetime is defined by how long the customer purchases from the company.
Think of one of your favorite subscriptions. If you subscribe to an annual service for 5 years, and pay $100 each year, your lifetime value to the subscription is $500.
3. LTV Formulas
If we generalize this formula, we arrive at one way of calculating LTV:
LTV equals the period price (annual, monthly) multiplied by the average lifetime.
Where average lifetime is the number of periods the average customer purchases for: in years if the pricing is written annually, and in months if the price is written monthly.
For companies that may not have a clear monthly or annual sale cadence, you can calculate LTV as:
LTV equals the average revenue per customer divided by the churn rate. Or,
LTV equals the total revenue divided by the total number of customers, which is then divided by the churn rate.
4. Churn
Churn is defined as the rate at which customers stop purchasing from the company over time. For a healthy software business, churn is between 3 – 8%; but this varies significantly for other types of companies across industries.
Marketing analysts will often examine typical customer purchase patterns to identify a churn window. For example, if a customer hasn’t purchased from the company in the past 3 months or 6 months, the company might consider that customer as churned depending on their line of business.
For membership-based businesses, like fitness studios and subscriptions, churn is easy to measure: any customer who has canceled their subscription would be considered to have churned.
5. Cohorts
Let’s return to our formulas briefly.
You’ll notice each formula contains an average: average lifetime, or average revenue per customer. In many cases, looking more closely at this average will reveal cohorts, groups of customers who behave similarly. Once marketing analysts identify cohorts; possibly customers who bought their first product around the same time, or a group of customers who had the same total lifetime value, they conduct analyses by cohort. For example, do cohorts that have a higher average spend tend to join via a specific marketing channel?
6. Cohorts: lifespan example
Looking at cohorts can reveal important traits about your business. For example, say the average lifetime of a customer for a boutique fitness studio is 3 years, or 36 months. This could be the average of two cohorts of equal size: one cohort who signs up for 1 month, and another cohort who signs up for 71 months. If the cohorts are of roughly equal size, the average will be 36 months: but these are two very different stories. Half of the customers are trying for a month and leaving, while the other half stay for almost 6 years!
These differences in customer behavior lead many companies to have their marketing analysts look at cohort analyses in addition to calculating LTV.
7. LTV/CAC
At the beginning of this video, we mentioned the LTV/CAC ratio, which describes marketing's ROI, or return on investment.
CAC stands for customer acquisition cost; the cost marketing must spend, on average, to acquire a new customer. An LTV/CAC ratio of greater than 1 means customers, on average, are worth more than what was spent to acquire them. The higher the LTV/CAC ratio, the better. We’ll review this more closely in the next section.
8. Let's practice!
Ok! Now that you’re more familiar with LTV, let’s move onto some exercises!