Life Time Value $ (LTV) = the cumulative Gross Margin $ (GM) of a customer (over their lifetime), less the Cost Per Acquisition $ (CPA) and lifetime Cost To Serve $ (CTS)
The formulas for the components of LTV are below;
Gross margin $ (GM) = the direct profit a customer generates. Sales less your cost of goods sold, over the lifetime of the customer.
Cost per acquisition $(CPA*) = all sales and marketing costs invested to acquire a customer. This is a one off cost.
Cost to serve $ (CTS**) = the cost of serving this customer once acquired this includes overheads and support teams. This is calculated as an ongoing cost over a customers lifetime.
An example of how to calculate customer life time value (what each customer is worth to you)
Sunshine Gardens provides a garden maintenance service
In 2016, they spent $100K on marketing– across print, classifieds, google ads and facebook.
200 new clients were acquired in 2016. Cost per acquisition $ (CPA) $500 calculated by; $100,000 in marketing / 200 customers
Each customer spends $100 on garden maintenance per month and stays as a customer for an average of 24 months (note you need to know the entirety of time that they are a customer). It costs $40 in labour per garden per month. Lifetime Gross Margin $ (GM) of $1,440 calculated by; 24 months x $60 GM (price $100 – labour $40)
Ongoing costs of an administration team to organise bookings and coordinate the gardeners. 2 people costing $100,000 in 2016. In 2016 they had 400 clients in total (200 acquired in 2015 + 200 in 2016). Cost to Serve $ (CTS) was $500 calculated by; $100,000 admin spend / 400 customers * 2 years (client is retained)
LTV $440 = GM $1,440 – CPA $500 – CTS $500
Sunshine gardens is making $440 per customer over their lifetime
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*CPA – this is probably the hardest number to calculate. How do you apportion the cost of brand, PR and activities which are not directly attributable to acquiring a customer? It’s hard. To simplify this (sum your last twelve months of sales and marketing costs, then divide it by the number of new customers acquired during this period). This will give you a rough idea of how much each customer costs to acquire. This is a one-off cost.
**CTS – this represents your ongoing costs to retain a customer. This includes customer service costs, account management, discounts / offers used to upsell or drive repeat purchase, hosting if you’re a software business etc. This is an ongoing cost.