Ecommerce business owners may measure their store’s success with metrics such as site conversion rate, having a positive revenue stream and ROI (return on investment).
While all of this data provides an excellent look into the short-term health of your Ecommerce biz, the only way to truly get a clear look into the projected future success of your business is by knowing the lifetime value (LTV) of your customers.
At some point or other, most business owners have found themselves thinking, what is the lifetime value of a customer? How do I calculate this? And, perhaps most importantly, why should I care?
The lifetime value calculates how much each of your customers is worth to you, and it also takes some of the mystery out of trying to guess how your future customers will spend their money on your site. In other words, it portrays how much value they will bring in the long-term, not just the immediate. This is critical information for a business owner to know, as it sheds light on what budget to aim for when acquiring a new customer. For example, if your LTV predicts the lifetime net profit of your average customer to be $500, you will have a larger budget to work with in acquiring new customers than someone whose LTV is just $50.
All customers are not created equal. In fact, according to Shopify, the top 1% of most Ecommerce customers are worth up to 18 times more than average customers.
Many business owners have never attempted to calculate the lifetime value of their customers because they have written it off as being too complex to measure. However, calculating the LTV of your customers boils down to just three pieces of data: Average Order Value, Purchase Frequency, and Customer Value.
Average Order Value
While it may seem self-explanatory, the average order value is the average amount that your typical customer spends when they place an order. To get this number, take your total revenue amount divided by the number of orders you received during a specific time period.
Average Order Value = Total # of Sales / Total # of Orders
To calculate this metric, you will want to make sure you use the same timeframe that you used when calculating the Average Order Value. Then, simply divide your total number of orders by the total number of customers.
Purchase Frequency = Total # of Orders / Total # of Customers
The Customer Value metric portrays the monetary value that each customer brings to your biz on average. (Again, make sure to use the same timeframe as you used to calculate the metrics above for accuracy). To calculate your Customer Value Average, simply multiply your Average Order Value by your Purchase Frequency.
Customer Value = Average Order Value x Purchase Frequency
Now that you have calculated these three important metrics, you have the information needed to calculate the Lifetime Value of your customers!
Calculating the LTV is now as simple as multiplying your Customer Value and the average customer lifespan. As the name implies, the average customer lifespan can be found by determining the amount of time a customer typically lasts before they become inactive and permanently stop making purchases from your store.
When it comes to your Facebook advertising campaign, there simply could not be a more important number to know on your customer. This is because the lifetime value of your customers directly affects the projected ROAS you can achieve. In other words, if your business has a higher LTV, then you have more flexibility in acquiring new customers. This allows you to advertise crazy promotions which translates into a LOT more money for your business in the long-run!
Well, there you have it! Now that you have all of the aforementioned metrics mapped out, you can figure out an accurate customer acquisition budget, as well as find ways to continually improve your metrics and LTV! As we have covered before, knowing the average LTV of your customers will translate directly into more profit for you as you advertise even smarter.
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