Lifetime value (LTV)

The formula

The simplest version, enough for most small firms:

LTV = average order value × orders per year × years a customer stays.

The more accurate version counts profit rather than revenue: take the cost of the goods and of delivery off every order. Profit per customer is the ceiling on what winning that customer may cost.

Example

A pet food shop has an average order of €40. The average customer orders 6 times a year and stays 2 years: LTV = 40 × 6 × 2 = €480 in revenue. At a 30% margin that is €144 of profit per customer.

If a first order through advertising costs €35, the ad looks like a loss on the first order alone (€12 of profit). Over the customer’s whole life the same €35 comes back four times. A furniture shop paying the same €35 per order is in a different position: its customers buy once every few years, and LTV is close to the first order.

Why it matters for a business

LTV is read together with customer acquisition cost (CAC). A common rule of thumb is that LTV should be at least three times CAC. Below that, growth eats the cash; far above it, the firm is probably spending too little on winning customers.

LTV also rises without advertising: a reminder to reorder, a subscription, a loyalty programme, better service after the sale. Each of them makes every later customer worth more.

What to ask

• Do we calculate LTV on revenue or on profit?
• How many times a year does the average customer order, and what share orders a second time?
• What is the ratio of LTV to CAC by channel?
• Do we split customers by source: do those from ads and those from search stay equally long?

In the Google Ads accounts we run, cost per click and budget are set against LTV, not only against the first order.