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Explaining the Power of LTV in Ecommerce

the word ecommerce is written on the calculator screenthe word ecommerce is written on the calculator screen
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written byEPAM Startups & SMBs

The Editorial Team of EPAM Startups & SMBs is an international collective of tech consultants, engineering managers and communications professionals who create, review and share their insights on business technology and project success tips.

The Editorial Team of EPAM Startups & SMBs is an international collective of tech consultants, engineering managers and communications professionals who create, review and share their insights on business technology and project success tips.

When tracking the success of an ecommerce store, you might look at metrics like sales, cost of goods sold (COGS), and the returns on your advertising. While these are all important metrics, they typically don't consider the long view. To track long-term eсommerce results, one metric to look at is LTV, or lifetime value.

LTV, also known as CLTV or CLV, is an important metric for tracking customer retention and loyalty. As a measure of the relationships you have with customers, LTV eсommerce tracking can help you with strategic decision-making. In this article, you'll learn more about how you can use LTV in your business.

What is LTV?

Lifetime value (LTV) measures the average revenue that an individual brings to you over their lifetime as your customer. Unlike other sales metrics, LTV goes beyond the one-time transactions a customer has with your business. Knowing what the average customer lifespan brings to your business helps you plan for future cash flows.

LTV provides you with data on the number of loyal customers you attract. While there are many ways to track this, for now, consider how its value compares to other metrics. Monthly sales, for example, provide you with information that includes newly acquired customers. While this data is important, your repeat customers are already comfortable spending money on your website.

These repeat customers represent the second phase of the sales funnel, the renewal of purchases. Think of it like a restaurant. If a customer enjoys the food, they will come back. As a customer enjoys more meals, they're more likely to continue eating there.

For these industries, more enjoyable meals make for a higher customer lifetime value. In an eсommerce store's case, more purchase frequency is a sign of higher customer value.

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Why is LTV an important metric for ecommerce business?

LTV is an important metric for eсommerce businesses because repeat customers reduce overall customer acquisition costs (CAC). This is because customers have already overcome the first few stages of the sales funnel.

A sales funnel usually goes through four different stages before a purchase: awareness, interest, consideration, and evaluation. Naturally, these stages take time to get through as customers research your company and products. Once a purchase is already made, some aspects of the awareness and interest stages have already been completed.

So, as long as the customer experience was good the first time, they are more likely to make another purchase. Customer lifetime value calculations recognize this, and measuring it can help you understand your customer retention rates better. Through its measurement, you can make decisions to support this customer base.

Without knowing LTV, you're stuck in a continuous cycle of attracting new customers. This costs you more, as you have to bring these customers through the entire sales process from the beginning.

More benefits of calculating LTV

Sidestepping the entire customer acquisition process is great, but what else can LTV give you? Here's a list of benefits you can get from including this on your metrics list:

  • Increased revenue over time.
  • An understanding of how to nurture customer relationships.
  • A strategic focus that attracts more valuable customers.
  • Reduced rates of customer churn.
  • A better understanding of how to address customer retention issues.
  • Simplification of the financial planning process.

LTV can be used alongside other methods of information gathering to help you pursue a holistic approach to customer acquisition. LTV is helpful, but it should be combined with feedback and customer behavior measurements to be truly effective.

No information, even if helpful, can be completely useful by itself. But if you want to improve customer lifetime value, it helps to know how to calculate LTV.

Models of LTV

When measuring customer lifetime value, there are two main approaches: predictive and historical. These approaches can be used together, but must be considered differently due to information sources.

Predictive

While relatively new, predictive analysis has become increasingly handy, especially for new business owners. Predictive analysis helps companies anticipate customer needs based on various data points, including similar companies.

In the modern era, predictive LTV has grown to include artificial intelligence and machine learning. These relatively new aspects of predictive reasoning can help automate processes like customer segmentation and inventory forecasting. This varies depending on the complexities of the model.

For example, you could use predictive LTV and AI to collect customer feedback more efficiently. AI modes can be incredibly efficient at taking important information from overly complex survey questions.

Even without AI and machine learning, predictive analysis relies on different analytical models you can rely on today. For example, you can use a clustering graph to estimate how your customer spends over time. This relies on a combination of past and present data, which brings us to our next approach.

Historical

The historical approach to LTV relies completely on past data. If you want to measure customer lifetime value, this approach is simpler and more predictable. However, it doesn't account for future potential impacts.

For instance, if you want to compare the results of different customer loyalty programs, you can use growth rates from the past few years. But that past data might not account for an increasing number of inactive customers. As a result, the data you receive might be inaccurate.

You can account for this by including automated systems that separate people into customer segments. But even so, uncommon events, such as inventory delays, might skew this information.

If possible, it's better to stick with a holistic approach. Relying on both historical and predictive data helps you plan for different potential impacts. Knowing what to do in a low-earnings vs high-earnings situation helps you plan for varying total revenue rates.

How to calculate LTV in eсommerce

Using a simple formula, LTV can be calculated through this formula:

CLTV = Customer Value (CV) X the average time a customer is retained (ACL)

The customer lifetime value formula can vary depending on your needs. For example, if you run a subscription box business, you might separate customers who pay by the year from customers who pay monthly. You'll see the formula for both CV and ACL below.

This is part of why the two forms of calculating customer lifetime value are important. New eсommerce companies might not have this information. Instead, they must rely more on the projected values from similar companies.

LTV metrics

The customer lifetime value calculation includes a variety of additional metrics. These metrics fill out the gaps of the vague terms used in the LTV formula. Below, you'll learn more about how you can use these metrics to better understand your numbers.

Average Purchase Value

The Average Purchase Value (APV) takes a company's total revenue and divides it by the number of orders. This value measurement can be done over a day, a week, a month, a year, or as far back as the company's formation. APV is part of our CV calculation from above.

For example, if your company makes $10,000 in monthly revenue and has about 1,000 orders a month, your APV is $10 on a month-to-month basis. Depending on the company, this might be a sign you'll want to reduce your costs or increase your pricing. Combined with other data sources, the APV can be very informative.

Analyzing this data by itself also enables business owners to understand customer behavior. For example, it might give businesses an idea of how to improve cross-selling. You can also use this information to adjust your pricing strategy.

Seasonal companies, such as those who sell skis, might find inconsistent data. When measuring these metrics, it's important to allow for a margin of error. In other words, add or subtract a bit from your data to consider how being slightly off will affect your strategy.

Considering segmentation, dividing customers by group might also skew this data. Consider how different groups behave when developing strategies built on the APV.

Average Purchase Frequency Rate

The Average Purchase Frequency Rate (APFR) is found by dividing the number of purchases over the number of customers. It is part of the CV formula below, and is helpful in defining how fast your stock is taken off the shelves.

For example, if you make 1,000 sales a month and have 5,000 customers, your monthly APFR is 5. So, the average customer makes five sales per month, totaling to 60 sales per year.

The frequency rate is particularly helpful for companies wanting to set up systems for ordering inventory. Relying on the frequency rate can help you avoid stockouts, maintaining a more effective cash flow. This metric is also ideal for identifying successful loyalty programs, such as referral codes.

Much like the average purchase value, you can get skewed data by relying too much on a single customer segment or having seasonal sales jumps. To avoid this, you could focus your data gathering to specific segments or seasonal periods. Having a holistic big and small picture approach can be helpful.

Customer Value

The Customer Value (CV) is the multiplied total of Average Purchase Frequency Rate (PFR) and Average Purchase Value (APV). Said another way, this number tells you how often your average customer buys and how much they pay in a single number. This number is part of the CLTV formula you can find at the beginning of this section.

Using our examples above, our PFR and APV are 5 and $5. This means your customer's monthly value is $25 monthly (or $300 yearly). Assuming this is for your overall customer, you can dive deeper into this data to find out which customer segment is providing the most value. You can then use this data to focus your advertising efforts towards this segment. This is just one example, and the data you make could mean many things for your business.

If you're like most eсommerce businesses, your average customer might have wide variances. One segment of customers spends more than the other, which is natural. This is why relying solely on "overall data" can be detrimental.

Excluding certain groups, such as your most loyal customers, might be more useful for your needs. This is why it's important to define your goals before gathering information. This way, you can find data that helps support reaching those goals.

Average Customer Lifespan

The Average Customer Lifespan (ACL or CL) is the total of customer lifespans divided by your current customers. Like the frequency rate, this relies on a specific number of customers. So, instead of relying on a wide range of data, it relies on a single day. You can find this metric in use on our LTV formula above.

For example, let's say you find out that your average customer lasts three years, and you have 5,000 customers. This makes your lifespan 0.0006 years, meaning that many customers either spend once or last a few months. In other words, 0.06% of your customers will last after three years. Using other sales terms, this means you have a churn rate of 99.94% after three years, which might be a sign you need to improve retention programs.

Average customer lifespans tend to look a bit lower than they should because customer retention is difficult. New businesses often struggle to find the perfect customer. Existing customers can be an excellent source of information when understanding this. So, try not to get discouraged when finding your ideal customer.

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How to increase customer LTV

Customer lifetime value isn't just a measurement to have, it's a guidebook on where you need to take action. How you need to take action depends on the results you find.

Optimize your onboarding

Onboarding, or the process of bringing people into the customer pool, is vital when increasing customer experience, especially in the first few months.

This applies to all kinds of products because customers might not now know how to use them.

For example, instruction manuals are important for all products, even simple ones. This is because there are often common misconceptions on how to use a product based on how it looks. Manuals provide an easy place to start when learning how to use new products.

To improve this process, provide instructional videos (like through a YouTube channel) teaching people how to use your product. While this might seem unnecessary for very simple products, it's better to be informative than assumptive.

When selling software, this help can come in the form of a built-in tutorial. Provide a list of steps that customers must take to understand all product features. You might also provide incentives, like an extended free trial, for going through those incentives.

In other words, if you want to increase customer lifetime value, you start from the beginning.

Increase average order value

Another way to boost your LTV is by focusing on one of the metrics mentioned above: APV. This term is interchangeable with Average Order Value (AOV).

To do this, you can take any of the following approaches:

  • Increase the price of the product
  • Get customers to buy more products

Typically, the second of the two options is received better because it focuses on customer value.

For example, think of the last time you went through a sales funnel with an insane discount. The person selling the product might say that the product they sell has an average value of $999. But instead, they're selling at a cost of $49.

Using this approach, you can provide bonuses or add-ons that your target customer might appreciate. For example, B2B companies might offer one-time guidance calls on how to use the product. Otherwise, their high-value customers get an assigned account manager. In this way, multiple pricing tiers come with valuable items.

Otherwise, you might include bundling opportunities on your eсommerce site's checkout page. Alternative options might include limited-time discounts, deals with a timer, and loyalty incentives for additional products. Consider which customer segment you want to focus on when deciding on a strategy.

Build long-lasting relationships

Another part of increasing customer lifetime value is to improve customer relationships. Naturally, a good experience makes people want to stay longer. This starts with excellent customer service after the purchase, but begins with any new customers before the purchase.

An easy way to start this is to build communities through social media. Find out more about the social media platforms your customers commonly use and create a page for those platforms. Then, you can regularly share information on how to use your product alongside more general advice for your target industry.

Some businesses take this a step further, using chat systems on Slack and Discord to cultivate relationships more. These chat platforms foster greater support, helping improve customer satisfaction throughout the product's lifetime. The most valuable customers within these chat rooms act as advocates on your behalf, eagerly helping members of the community.

To improve the average lifetime of any customer, the experience must be good through onboarding to loyalty. This helps build brand loyalty around your product, helping you keep more customers.

Embrace good advice

When seeking out strategies to encourage repeat purchases and improve customer engagement, it helps to speak with people who have experience in the field. While each customer brings valuable information, the actions you take can also come from veteran sellers.

Via websites like Facebook and LinkedIn, you'll find various communities where eсommerce agents communicate. These individuals speak to each other, sharing advice to help the community thrive. This is similar to the social communities you can create. These communities are often built into B2B product providers. In some cases, you don't need to buy the product to access the community.

You can also reach out to fellow eсommerce providers through direct messages, but some will not provide you with information unless you provide something in return. The same could be said for any community, so be ready to share your experience to help others. Active members are essential for the prosperity of any community.

Empower easy connections

Whenever possible, take steps to remove barriers from the customer journey. This starts by making your website easy to navigate, leveraging social sales platforms, and simplifying the checkout process. Your typical customer won't stick around if your product is difficult to buy.

Loyalty programs also benefit from this simplified connection. Make those programs easy to access and valuable for your loyal customers. Provide exact steps on how to access your loyalty program. You can also create a separate social channel for these individuals, providing a portion of sales or discounts for future purchases in exchange for proven references.

The entire relationship, from beginning to end, must be simple to access. With more complex processes, you might consider bringing in a third party to help audit your ecommerce processes.

Improve customer service

To empower long relationships and attract new customers, you need good reviews. This comes by having a responsive customer service team. This not only increases your customer retention rates, but improves your chances of making a sale due to positive reviews.

If you're just starting a new business, this means taking steps to avoid overwhelming yourself. Make a smaller number of sales to start, ask for reviews inside your packaging, and be prompt in your customer responses. Pay special attention to customer segments who provide you the most value.

Customer acquisition costs, as a result, are a necessary part of running your business. Eventually, your goal should be to outsource customer support. This way, you can focus on growing your business instead of managing it. Both are important, but a stagnant business will eventually run out of money.

How can EPAM help you?

At EPAM Startups & SMBs, you can get help with the most important stages of developing your eсommerce business. Our services include the following:

If your goal is to improve customer retention, it's important to outsource aspects of your process. This could include marketing efforts, customer communication, and tools to automate the encouragement of repeat purchases. It's best to supplement areas where you aren't the expert, so you can rely on the expertise of others.

Implementing these changes through services found at EPAM Startups & SMBs can help you scale your business and rely on expert services. To learn more, contact our team of eсommerce experts today.

Conclusion

To calculate customer lifetime value (CLTV), it starts with understanding important metrics. These include customer value, customer purchase frequency, how long customers remain, and the average value of a customer purchase. Knowing these four simple metrics involves relying on a lot of data, and it can be improved by considering different customer segments and being aware of different periods.

It's just as important to draw conclusions from this same data. Deciding on various potential actions is often involved in reaching these conclusions. Data is most important when focused on specific business goals, which might include improving short-term sales or long-term retention. Keep this in mind when calculating customer lifetime value.

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written byEPAM Startups & SMBs

The Editorial Team of EPAM Startups & SMBs is an international collective of tech consultants, engineering managers and communications professionals who create, review and share their insights on business technology and project success tips.

The Editorial Team of EPAM Startups & SMBs is an international collective of tech consultants, engineering managers and communications professionals who create, review and share their insights on business technology and project success tips.

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