RMT366 Spring 2020 discussion

calculating

Lifetime ValueLifetime Value a case study »

14 25.50 25 39 18

avg. customer value per week (expenditures × visits, in usd)

customer 1 customer 2 customer 3 customer 4 customer 5

3.50 8.50 5 6.50 6 customer 1 customer 2 customer 3 customer 4 customer 5

4 3 5 6 3 customer 1 customer 2 customer 3 customer 4 customer 5

customer expenditures per visit

number of visits per week (the “purchase cycle”)

avg. across 5 customers (in usd)

24.30

avg. across 5 customers (in usd)

5.90 avg. across 5 customers

4.2

One way to analyze acquisition strategy and estimate marketing

costs is to calculate the Lifetime Value (“LTV”) of a customer. Roughly

defined, LTV is the projected revenue that a customer will generate

during their lifetime. In this graphic we’ll briefly cover how to calculate

LTV and how to use LTV to help solidify your marketing budget.

Special thanks to @avinash.

Case Study: Starbucks Despite the shaky economy, Starbucks is opening new stores around the world. In 2012, Starbucks

expects to open 600 new locations internationally, about 25 percent of which will be in China. It’s no

secret that Starbucks’ acquisition strategy is closely scrutinized and routinely copied. Using rough

sales figures from 2004, we’re able to estimate the LTV of an average Starbucks customer. The sales

data from Starbucks may not reflect current marketing trends, and is only provided to illustrate the

steps necessary to calculate LTV.

»

$ $$

$ $

$

$

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Step 1: Average Your Variables

Step 2: Calculate Lifetime Value (LTV)

simple ltv equation custom ltv equation traditional ltv equation

52(a) × t t(52 × s × c × p) m ( )r1 + i - r

constants

Companies like Starbucks will typically use several different equations to calculate the LTV. We’ve included

3 common LTV equations below. Companies will typically use these equations (separate or in combination) to

help determine their marketing budgets, and, ultimately, the cost of acquisition.

equation filled equation filled equation filled

52(24.30) × 20 20(52 × 5.90 × 4.2 × 0.213) 5382.94 ( )0.751 + 0.1 - 0.75

$25,272 $5,489 $11,535 calculated ltv calculated ltv calculated ltv

Breaking Down LTV Further

average ltv

Satisfied ( 27% )

Very Satisfied ( 62% )

:)

= )

Not Satisfied

( 11% )

:(

ltv will be different for different kinds of customers

Step 2 in this graphic is intended to help you determine LTV as a total average (an average of all your customers). To do this, companies

will typically average the data from randomly chosen customers (as shown in Step 1 above). Sometimes it’s helpful to break down the

average further and perform separate LTV calculations for different kinds of customers. Try and segment your customer base by total

purchases over a long time period, and it will help you determine the LTV of a “good” customer versus an “average” one. This type of

analysis will help you determine how much more you should pay in order to acquire a “good” customer. See chart below.

investing in “good” customers

Companies should be worried about the lasting impact of “buying cheap

customers.” How likely are these customers to buy another product,

or hang around for a few years? Sometimes it pays to invest in “good”

customers. “Good” customers might cost more to acquire, but they’ll

likely be more profitable as well.

Let’s say that the LTV of an “average” customer is $8,000, and the LTV of

a “good” customer is $10,000. By subtracting the two LTVs, you can see

that you might expect to pay $2,000 more to acquire “good” customers. ltv of an

aver age customer ltv of a

good customer

$2,000

$8,000 $10,000

s o u r c e s espressocoffeeguide.com wikipedia.org starbucks.com kaushik.net

*essays24.com scribd.com investopedia.com istobe.com

(s)

(c)

(a)

different ways to calculate ltv

By calculating the LTV of an average customer, Starbucks can now begin to estimate

the maximum acquisition cost of a new customer. Using our estimate (an average of

several LTV equation results), Starbucks must spend less than $14,099 to acquire new

customers. If Starbucks spends more than $14,099 per acquisition over the course of an

average customer lifespan (20 years), there’s a chance that they could be losing money.

t The Average Customer Lifespan (how long someone remains a customer). In the case of Starbucks, the average customer lifespan is 20 years.

Customer Retention Rate. The percentage of customers, who, over a given period of time, repurchase, when compared to an equal and preceding period of time. Starbucks: 75%.

r

The Rate of Discount. The “rate of discount” is the interest rate used in discounted cash flow analysis to determine the present value of future cash flows. Usually this number falls between 8% and 15%. Starbucks: 10%.

i

Avg. Gross Margin per Customer Lifespan. Starbucks has a profit margin of 21.3% (see constant “p”). If the average customer spends $25,272 (see the “Simple LTV Equation” results below) during their time as a customer (“t”), Starbucks has gross margin per customer lifespan of $5382.94.

m

Profit Margin per Customer. Starbucks: 21.3%.p

One of the most effective ways to boost LTV is to increase customer satisfaction. Research has found that a

5% increase in customer retention can increase profits by 25% to 95%. The same study found that it costs six

to seven times more to gain a new customer than to keep an existing one.

The success of Starbucks could be attributed to its high customer satisfaction rate (89%, 2002, see below).

Survey software, such as KISSinsights, can help you determine (and improve) your customer satisfaction rate.

Calculating LTV can help you see how profitable customers are—and how

much should be spent on acquiring them. KISSmetrics is a powerful web

analytics solution that has built-in support for lifetime value and can help

you identify which marketing channels deliver the most valuable customers.

Give us a try! Try KISSmetrics for free: kissmetrics.com/signup.

$14,099

ltv

$900 ltv

$12,000 ltv

$600

KISSmetrics can help you identify which marketing channels deliver the most valuable customers.

This is just the beginning

Customer Satisfaction Boosts LTV

customer satisfaction at starbucks*

people pay you. Not pageviews. KISSmetrics is a powerful web analytics solution that helps you make

smarter business decisions. Start your FREE trial at kissmetrics.com/signup