January 26, 2018

Calculating Customer Lifetime Value for eCommerce

What is your average customer worth to you? It’s an important question to answer, especially if you’re an eCommerce retailer. Finding the answer to that question could play a part in determining your marketing approach when it comes to channels and expenditures. One of the more common ways to determine how valuable a customer is to you, is to apply the lifetime value calculation. It determines the projected revenue that a customer will generate for you over their lifetime. In its simplest form, below are a few steps to take to calculate lifetime value.

For this walkthrough, we’ll view this through the eyes of an eCommerce retailer, but the lifetime value calculation can be applied in a variety of B2B and B2C settings. It’s also important to note that you can get very granular about calculating this metric, but we’ll keep this very simple which involves just a little bit of basic arithmetic. We’ll also just look at a handful of orders and customers, but it’s probably best to get a full year’s worth of data.

The first thing you’ll need to do is to find the average order value. Most times you can find this information in the admin of your website, but if not, you should easily be able to export this data into an excel type spreadsheet and average out the total. You’d want to collect a large enough sampling to obtain an accurate average as mentioned, which is why you wouldn’t want to look at anything less than a month’s worth of data - depending on your order volume.

Orders:
$32 + $43 + $112 + $94 + $72 + $35 = $65


After determining your order average, you’ll want to look at the frequency of purchases per customer. This is also something you should be able to obtain from your website’s admin. Is your product offering more of a one-time purchase? Or, do you offer products that will likely need to be replaced over time? If you’re selling t-shirts, there’s a high probability that a customer will come back for future purchases as styles and seasons change, or simply from wear-and-tear. For the orders we mentioned above, let’s look at how frequently those particular customers made a purchase over the course of a year and then we’ll average it out as well.

Number of orders for customers mentioned in our calculation above (annually)
3 + 4 + 1 + 7 + 4 + 2 = 3.5


Now that we know the average order amounts to $65 and the average customer places 3.5 orders per year, we know a customer is worth $227.50 annually. The last thing to add in would be the lifespan of those customers. How long does someone stay loyal to your brand? Or, how long do they stay in your targeted demographic? Could be as low as a year or less, or upwards of 20 years or longer depending on your industry. If you’re only selling kids t-shirts, it’s likely less than a year (unless it’s twins!) Let’s say the average customer sticks around for 4 years - you simply add that to the equation.

$65 (average order value) x 3.5 (average number of orders per year) x 4 (customer lifespan) = $910


So, in our brief example, the lifetime value of a customer is $910.

While knowing how much revenue you’ll generate with each new customer, it’s important to consider how much actual profit you’ll gain from each one of those customers. Multiplying your profit margin to the total above will tell you that. For this example, we’ll say you’re profit margin is 30%.

$910 (lifetime customer value) x 30% (profit margin) = $273


Calculating customer lifetime value is fairly straightforward, but there are a few other factors to consider:
  • Retention rate - how likely are you to lose a customer due to competition or a poor customer experience
  • Customer satisfaction - you can increase your customers lifetime value by increasing customers satisfaction. It’s a lot harder to find a new customer than to keep the ones you have
Customer lifetime value can provide great insight into how and where to place your efforts when it comes to digital marketing, but more importantly, how much it's going to cost you. If we can help you calculate your customers lifetime value and gain more customer, contact us today.
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By: Brian Henning

Director of Marketing