Customer lifetime value, often abbreviated as CLTV or LTV seems self-explanatory: the total profit you make from an average customer between their first and last purchase.
While the definition is straightforward, calculating it and understanding how to optimize and increase it can be more challenging. You need to strike a balance that’s right for your business by adjusting four key levers that affect LTV.
But at the end of the day, the secret to being more profitable is happy customers. The purpose of all these concepts and formulas is to help you find more efficient and effective ways to do so.
Customer lifetime value definition
LTV refers to the total profit you earn from the average customer over the course of time they’re engaged with your service, or over a specified timeframe.
It’s calculation most often associated with subscriptions because it’s relatively easy to see how much a customer has spent with you until the time they cancel. However, LTV can also take into account things like one-off purchases during a specific time period.
Part of the reason why subscription businesses have exploded in popularity over the last decade is a healthier than average LTV compared to businesses that sell to customers one transaction at a time. This is directly related to subscription companies getting higher valuations than single-purchase businesses.
Most importantly, a subscription means recurring revenue for your business without having to continually find new customers or convince former customers to buy from you again. Instead, every subscriber is a repeat customer by default.
Bold Subscriptions calculates LTV in your reports based solely on subscription revenue, but there are other factors, or levers, that influence LTV.
The four key levers of lifetime value
There are the four factors that influence LTV: customer acquisition costs (CAC), average revenue per customer (ARPC), cost of goods sold (COGS), and churn. In this book we’ll call them levers because you can adjust them to increase your LTV, but usually adjusting one will affect the others.
The trick isn’t necessarily to have each in its ideal state, but to find a balance that works for your business and then optimizing from there.
We’ll go into each of these and how they affect each other in more detail, but first, here’s an overview.
Customer acquisition costs (CAC)
CAC = Marketing Spend / New Subscribers (for a set time period)
This is how much it costs to get a new customer to buy from your store. Ideally you want this to be low because it means you’re attracting more customers for every marketing dollar you spend.
CAC is traditionally considered the sum of marketing expenditures divided by the number of customers you acquire in a given time period. For example, if you spent $25,000 in a quarter to acquire 2,000 new customers, your CAC would be $12.50.
Average revenue per customer (ARPC)
ARPC = Gross Revenue / Number of Subscribers (for a set time period)
This is the amount of money the average customer spends during a certain period of time. Ideally you want this to be high (and obviously higher than your CAC) because it means you’re earning more revenue from every customer — which usually means you have more potential for profit.
This is different than LTV because it doesn’t factor in the expenses that go into earning it that basically gets subtracted from this revenue.
Cost of goods sold (COGS)
COGS = (Beginning Inventory + Purchases + Expenses) – Ending Inventory (for a set time period)
The total cost of producing or procuring your products. Traditionally this metric focuses on manufacturing or acquisition, but logistics, shipping, and other overhead expenses, like marketing and transaction fees, may be considered. Ideally you want this to be low because the less you spend on products the easier it is to make a profit on every unit.
Churn
Churn = 1 – Customer Retention Rate
Customer Retention Rate = ((Subscribers at end of a time period – New subscriptions added during the period) / subscribers at the beginning of the period)*100
This is how many customers you gain or lose over a certain time period, usually measured as a percentage. Ideally you want this to be low because it means customers are staying subscribed for longer and therefore paying you more revenue.
The CAC:LTV ratio
There is an important relationship between CAC and LTV. Successful subscription businesses usually have a customer lifetime value that’s triple their customer acquisition costs. This is a good indicator of profitability because it usually means you’re taking in enough revenue to cover your costs and make a profit.
GRAPHIC: Checkout out our LTV calculator
Subscription companies that can’t reach this threshold will likely struggle with cashflow.
If things are off-balance, there are four ways to get a healthier LTV:
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- Reduce your CAC
- Increase ARPC
- Decrease COGS
- Reduce churn
How to reduce CAC
CAC is particularly relevant for subscription-based businesses because you may be willing to have higher CAC costs in exchange for longer-term recurring revenue relationship with your customers.
Decreasing customer acquisition costs is beneficial because it means you’re recruiting more customers for every marketing dollar you spend. This give you more room to spend on COGS and less pressure to increase ARPC in order to be profitable.
The most direct way to improve your 3:1 LTV to CAC ratio? Find more affordable ways to recruit new subscribers.
Convert one-time purchasers to subscribers
Here are a few affordable ways to turn your current customers into subscribers. Since they’re already buying from you, they’ll probably be easier to recruit on to your subscription.
Spread the word about your subscription
Make sure every visitor to your store knows you provide a subscription service. Put a link in your navigation and in a widget on pages of products that are available as subscriptions.
Pre serves up quality beef products and uses a smart callout to their subscription model in their top nav. This lets all their customers and any first-time visitors know that they provide a subscription service.
Provide a financial incentive
Give customers a reason to subscribe instead of just buying once. Discounts for subscribing are a great way to do this. With Bold Subscriptions, you can build a discount right into your recurring order option to help attract new customers.
Pre also promotes the discount subscribers get on their site.
Promote easy cancellations and flexibility
Consumers might be hesitant to commit to a subscription, that’s why it’s important to provide a flexible service and then communicate that to potential subscribers.
Letting people know they can skip and pause orders, and even easily unsubscribe, can them feel more comfortable.
CBD products are meant to help people relax, and Clean Remedies keeps up this ‘peace of mind’ concept in how they promote their subscriptions. This handy infographic promotes the customer’s ability to save money, set the frequency, and skip, pause, or cancel with ease.
Effects of reducing CAC
If you can effectively lower CAC, you’ll give have more room to be profitable even if the other three levers are at a less than ideal state. It allows:
- Lower average revenue per customer
Because you’re spending less to get every customer, you don’t need as much revenue from them to cover acquisition costs. This usually means it’s cheaper to acquire new customers than to persuade existing customers to spend more (particularly for single-product subscriptions). - Higher cost of goods sold
Because you’re spending less attracting customers, you can afford to spend more on your products. Often, higher COGS leads to higher-quality products, which is what attracts customers to your brand and brought you a low CAC in the first place. - Higher churn
Because you can afford to get new customers when others leave since the cost of acquiring them is low (likely thanks to viral word of mouth). Higher churn rates may also be common with subscriptions that don’t need to be fulfilled as often.
To learn more about CAC and how to reduce it, download our free ebook. It also goes in depth into many other aspects of LTV and included dozens of real-life example on how merchants are reducing customer acquisition costs.
How to increase ARPC
Ideally you want to increase average revenue per customer because the more revenue you can take in, the more potential you have for profitability. It also gives you more room to increase spending on CAC and COGS while making low churn less necessary.
Here are a couple of strategies to help you show subscribers that spending more with you is worth it, bringing them more value and bringing you more revenue.
Upsell your customers, more products more often
Giving your subscribers the ability to add products to their orders not only gives them the convenience of flexibility, it also gives them the opportunity to add more to their orders.
- Encourage customers to increase their frequency: find customers who are only getting a few order fulfilled a year and provide incentives for them
- Add on products: Give subscribers access to exclusive discounts for one-time products or give them free samples, discounts, or other incentives to make their future orders bigger.
Dentist-friendly tea brand Tuthi has a cheeky way of encouraging higher shipment frequencies right at the onboarding stage by using information on how often subscribers drink tea to recommend ideal delivery timelines. While it’s great to promote delivery flexibility at the onboarding stage, consider letting your existing customers know they can up their frequency as well.
Create a tiered subscription
It absolutely makes sense to start with one subscription offering, but once you’ve got the model mastered, why not layer in additional models as a way to upsell your customers? You can charge them more for the benefits they receive from higher tiers. It can also reduce churn because they’re getting more than one benefit.
- Provide premium-priced products in an exclusive upper tier offering.
- Include more products with your premium offering.
- Add on additional benefits and perks for top tier subscribers, like free shipping or accelerated loyalty point earning.
Effects of high ARPC
Increasing ARPC will give you more room to be profitable even if the other three levers are at a less than ideal state because you’re taking in more revenue. Having a higher ARPC allows for:
- Higher customer acquisition costs
Because you have more money to spend on acquiring new customers. These levers will usually go hand in hand because connecting with loyal, high value customers will usually require a higher marketing spend. - Higher cost of goods sold
Because you can still make a profit off more expensive products. You probably have to spend more on your goods anyway to get customers to recognize the quality of your subscription offering. - Higher churn
Because you’re generating more revenue from every customer and especially your most devoted customer base.
How to reduce COGS
The majority of tactics related to reducing your cost of goods sold usually aren’t affected to customer behaviour, but here are a few tactics you can consider on the supply side:
- Negotiating shipping and manufacturing costs
- Buying in bulk to receive discounts
- Substituting lower-cost materials
- Using just in time (JIT) manufacturing
- Paying cash to get lower prices
However, there are a couple of simple strategies you can use to look at your costs in relation to customer experience.
For example, you can also survey customers to find out what’s working and not working and maybe reduce costs on customers don’t care about much. Things like fancy packaging and inserts could be expenses that aren’t worth their cost.
Reducing your COGS is another simple way to improve your LTV. If your overhead is lower, it means you can have:
- Higher customer acquisition costs
Because you have more money to spend on acquiring new customers. - Lower average revenue per customer
Because customers don’t need to spend as much for you to make a profit. - Higher churn rate
Because you have high enough profit margins to spend more on acquisition.
How to reduce churn
Reducing churn is one of the most important levers of them all because the longer a subscriber is with you, the more they’re going to spend, period. The good news? If you work on enhancing your subscription offering across the other three levers, you’ll probably have happier customers, meaning you’ll see lower churn without having to lift a finger. But here are some things you always look out for anyway:
- Avoid involuntary churn (dunning management) through automation (BSubs does this)
- Provide cancellation alternatives (like pause or skip – BSubs does this)
- Including other subscriber-only perks in addition to your main offering that customers might not want to give up.
- Offering incentives to stay subscribed for longer, like bigger discounts for longer subscription commitments.
Vitamin subscription service Vitally offers 1 ‘vitcoin’ for every $1 spent, and lets you apply points to save either $5 or $20 off your subscription order. A customer spending around $40 on a typical subscription order could start saving on their subscription in as little as six months.
The lower your churn rate, the more leeway you have for the three levers.
- Higher customer acquisition costs
Because most customers are staying with you for long enough to pay for the cost of acquiring them and then some. - Lower average revenue per customer
Because steady revenue month over month will likely outpace a limited-time big spender. - Higher cost of goods sold
Because customers are sticking around for longer, you’re bringing in more revenue. Chances are your subscribers are staying on board because they value the quality of your product. Having predictable recurring revenue can also help you anticipate your inventory needs so you can optimize your costs.
Results
Once you’ve invested in approving your approach to all four of these areas, ideally you should see the following:
- An increase in subscribers, based on your reputation and reviews.
- Lowered CAC, as customers flock to your subscription offering over others.
- Better subscriber retention, by creating a subscription that delivers higher perceived value.
- Increased customer satisfaction, through an exceptional customer experience
Learn more about optimizing your LTV
If you want to learn about to improve your LTV check out our free ebook, 4 Keys to Increasing the Lifetime Value of Your Customers. It includes a detailed breakdown of each lever and over 25 strategies on how to improve them, including real life examples.
Recurring revenue will already have your business on the track to increase LTV, but being mindful of these four levers and finding the right balance for you business can be a key to longterm success.
Whether or not you already offer a subscription service, Bold Subscriptions can create a flexible, user-friendly subscription program that attracts and retain subscribers. Contact us to learn more and get started with your one-of-a-kind subscription today.
This article originally appeared in the Bold Commerce blog and has been published here with permission.
