Definition
What is customer lifetime value?
Customer lifetime value is the total profit a customer generates over the entire span of their relationship with a company, net of the cost of serving them. It combines average order value, purchase frequency, the length of the relationship and margin. The figure tells the company how much it can afford to pay to acquire a customer.
The four components
Customer lifetime value is built from four figures the company already holds:
- Average order value tells you how much a customer spends on each purchase.
- Purchase frequency tells you how many times they buy in a year.
- The length of the relationship tells you how many years they remain a customer.
- Margin tells you what is left of each sale once the product, shipping, returns and service are paid for.
A change in any one of these figures changes the result. That is why lifetime value is tracked by cohort (customers acquired in the same month), rather than as an average across the whole customer base.
What it is for
Customer lifetime value sets the ceiling on what a customer can cost to acquire. Compared with customer acquisition cost, it tells you whether the company can invest more or needs to fix things before accelerating.
It also shows where the margin is. In online commerce, the first sale often pays for the acquisition: it is the purchases that follow that make the customer profitable.
Customer lifetime value = average order value × purchases per year × years of relationship × margin rate
The margin rate used is what remains once the cost of serving the customer is paid (shipping, returns, service). A calculation based on revenue gives a result that is flattering and wrong.
An online store has an average order value of $80. Its customers buy three times a year and remain customers for four years on average. Its margin, once shipping, returns and service are paid, is 30%. Customer lifetime value is $80 × 3 × 4 × 0.30, or $288. A customer acquisition cost of $100 leaves room to invest. A cost of $300 would lose money on every new customer.
We treat customer lifetime value as a figure calculated in-house. It comes from the accounting system, repeat purchase frequency and the real margin by product line: no outside vendor can rebuild it without access to that data. What can be delegated is the instrumentation and the cohort measurement.
We always read it alongside customer acquisition cost. As long as that ratio is unknown, raising or cutting a marketing budget is guesswork.
Not to be confused with
- Subscriber value
- Subscriber value measures the gross margin produced by a person on your list, whether or not they have bought. Customer lifetime value covers people who have already bought.
- ROAS
- ROAS compares the revenue attributed to a campaign with its ad spend: it measures revenue, not profit. Customer lifetime value keeps the margin and the purchases that follow the first sale.
Related concepts
Further reading
- Online commerce: where the margin really is
- Marketing metrics: the ones that change a decision
- Shoes, furniture, hardware: what your returns really cost
- Owners and executives: your email list is the only audience asset you truly own
- Marketing budget and plan: the benchmark figures and what they hide
Related services
Frequently asked questions
How do I calculate customer lifetime value if my business is new?
Start from a cautious assumption about the length of the relationship, then correct it every quarter as your first customer cohorts age. The calculation is based on your real margin, not your revenue.
Does customer lifetime value apply to B2B too?
Yes. Average order value becomes the average value of a sale, and frequency becomes the pace of renewals or repeat orders. The structure of the calculation stays the same in B2B and B2C.
