This term quantifies the return that a client will report to us throughout the commercial relationship with our company. For example: If we sell a product for $121 and we know that the average customer buys from us twice a year and then stops buying, what would the LTV be? First of all you have to know what components include the price. Focusing on the example, we have:
- PVP = $121
- Tax = $21
- Product cost = $50
- Gross margin = $50
To simplify the example, let’s imagine that we do not have fixed costs attributable to the product, such as the rental of offices, nor the salaries of the personnel necessary to carry out the sale. Taking into account the simplified example that we mentioned, the client will buy from us twice throughout the year. With which the client’s LTV will be the margin that we have previously calculated for two, that is:
LTV = $50 margin * 2 sales = $100
This is a simple way to exemplify how to calculate the LTV/ However, there are many ways to calculate it, one of the formulas that we consider to be the simplest is the following:
LTV = Margin * Recurrence / Churn Rate
The Churn Rate or Rotation Rate refers to the proportion of customers who stop buying from us for a certain period of time, which usually is one year. For example, if we know that out of 100 customers, 25 stop buying from us every year, this will be a turnover rate of 25%. In our example, the turnover rate is 100%, since they buy from us twice a year and then stop buying. However, what would the LTV be if our product is consumed once a year for three years?
Let’s calculate it: First of all, we must calculate the Rotation Rate or Churn Rate:
Turnover rate = 33%, a customer buys from us for 3 years 1/3 = 33%
Taking this turnover rate into account, the LTV will be:
LTV = ($50 margin * 1 Sale) / 0.33 = $150
As you can see, having a high recurrence (that they buy from us often) and a low turnover rate (that do not stop buying from us) positively influences the calculation of LTV. This is why it is so important to work on these aspects through customer loyalty plans using CRMs or marketing automation. Now you know what each client generates for you, you can calculate it, but you might still wonder how much you should spend on digital marketing campaigns. To answer this question we must consider factors such as CAC, Return on Investment, Return on Investment ROI, and the Rotation Rate or Churn Rate. Click the following link to learn step by step what you have to do to understand exactly how much you have to spend.