Shopify Ecosystem

How to Calculate Your Customer Lifetime Value

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When it comes to eCommerce, your single most valuable asset is your customer. While attracting new customers is part of eCommerce growth, it’s less expensive and more efficient to convert first-time customers into repeat customers than it is to obtain new leads. Because of this trend, tracking the lifetime value of your customers is vital to understanding the rate at which your company is growing on a long-term basis.

 

What is “Customer Lifetime Value”? Once you’ve converted a lead into a customer, you’ll want to do everything in your power to turn that customer into a loyal part of your company. When a customer makes multiple purchases from your store over the course of weeks, months, or years, their lifetime value increases. Customers with high lifetime value are crucial to the success of your company. When many of your customers have a very high lifetime value, you can begin to establish an accurate idea of your company’s performance with time. Revenue and conversion rates are excellent measurments for the short-term success of your store, but customer lifetime value gives you a glimpse at your company’s long-term success.

 

Measuring customer lifetime value isn’t as easy as calculating revenue or conversion rates. The lifetime values of your customers will vary from person to person, thanks to irregularities in how often your customers make purchases. This also depends on the products you sell, as perishables and consumables will lead to smaller, more frequent purchases by a number of customers, while clothing may show larger, less frequent purchases on average. While this makes customer lifetime value difficult to calculate, it also allows you to create an accurate prediction of future sales. Customer lifetime values can be used to forecast future purchases by your most loyal customers, allowing you to calculate potential revenue weeks or months in advance. This can be used in conjunction with your conversion rates to better understand the pace at which your company is growing.

 

There are three main variables present when calculating the lifetime value of your customers: 

 

  • Recency: When was the last time your customer made a purchase?
  • Frequency: Often often do your customers make their purchases?
  • Monetary value: How much do your customers spend when they make purchases?

 

Each of these variables should be calculated for your customers, and should be listed in an organized fashion. You’ll need to know the value of these variables in order to accurately calculate each of your customer’s lifetime value. These are the three main components that make up customer value, as they define how much and how often your customers make a purchase. The more often they make purchases, the longer period of time they’ve been making purchases, and the higher the value of those purchases will lead to a high customer lifetime value.

 

After you’ve established a database of each of these variables, you’ll need to assign value to them in the database. A customer who has only started shopping with you most recently should be assigned a “1” for recency, but could be assigned a “3” for frequency if they’ve made many purchases since, and a “2” if their purchases have been mildly valuable. These numbers should be added together (in this case, they add up to 6). After you’ve done this for each customer, list them in order from high to low, based on the final result for each customer. This list should then be broken into three segments splitting the high value customers from the mid-value customers, and finally the low-value customers. 

 

Once you’ve assigned general values to each of your customers, it’s time to begin the process of accurately calculating their lifetime value. Like any equation, this requires a specific algorithm in order to find the right number. You’ll want to begin by finding the average order value for each customer value group. This can be done by following this algorithm:

 

Average Order Value = Total Sales x Order Count

 

Prior to calculating the average value for each customer group, you’ll want to establish a time frame during which sales will be included – perhaps the past quarter or year. After calculating the average value of your customer’s purchases, you’ll need to calculate the average purchase frequency. This can be done using the following algorithm:

 

Purchase Frequency = Total Orders/Total Customers

 

Once you’ve established the average customer value and the average purchase frequency, you can use these numbers to discover the overall customer value for each of your customer groups. Use the following algorithm to establish the overall customer value for each of your customer groups: 

 

Customer Value = Average Order Value x Purchase Frequency

 

After you’ve accurately calculated the customer value, calculating the customer lifetime value is as easy as multiplying your customer value by the average lifespan of your customers. The lifespan of your customers is from the time they make their first purchase to the time they make their last, and the longer the customer lifespan, the higher your customer lifetime value will be. If you don’t have access to this data, it’s okay to use a placeholder instead of inaccurate data. A placeholder of one to three years should suffice to get an accurate depiction of your customer lifetime value.

 

Customer lifetime value is the lifeblood of your store’s success, and should be treated as such. It’s greatly important that you monitor the customer lifetime value as your company grows, as it will give you an excellent idea of how quickly and steadily you are growing. While difficult to calculate, understanding the customer lifetime value of your store is vital to properly measuring the long-term success of your business, and can be done by simply following the steps above.

 

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