Customer Lifetime Value Formula
Sep 12, 2024
As an e-commerce merchant, it is important to keep tabs on your customer lifetime value to monitor the actual revenue or profit your business is making from each customer.
However, an untargeted customer lifetime formula can lead to incorrect assumptions and flawed decisions. This is especially true when you use formulas that do not factor in key metrics such as retention, product cost, churn rate, and discount rates, among others.
While you can use apps like bloom analytics to discover CLV easily, we recommend that you understand the range of formulas to determine precise insight.
To help you nail the process, here are the different types of CLV formulas that you can use, ranging from simple to advanced.
We’ll start with the most basic.
Simple Customer Lifetime Value (CLV) Formula
The most basic (but less comprehensive) CLV formula is to calculate product price multiplied by the number of customer purchases
CLV = Product Price * Number of Customer Purchases
So if your product’s sales price is $10 and your customer has bought the same item 20 times in the first year, then your customer’s lifetime value for year 1 is $200.
However, this calculation is limited because it does not factor in COGS (product cost, or Cost of Goods Sold), acquisition costs, retention or any other key metrics.
Now, before we look at the formula that considers all of these factors, let’s examine a more holistic version of the same CLV formula.
A Holistic CLV Formula
A more complete version of the CLV formula is as follows:
CLV = (Product Price - Product Cost) * Number of Customer Purchases
Product cost, also known as Cost of Goods Sold, is the cost of each product or SKU sold, which should be deducted from the price of the product.
So if your product’s retail price is $10, COGS is $4, and the number of purchases is 20 in a year, then your CLV will be $120.
CLV = ($10 - $4) * 20 = $120.
Although this holistic calculation does not account for retention rate, churn rate, or discounts, it is a more profit driven formula than the basic one.
However, it’s typical that your product or SKU costs may vary by supplier. So, what if you have multiple product costs for the same item?
Customer Lifetime Value Formula With Varied Product Costs
To reduce manufacturing and inventory costs, you may be sourcing your product from multiple suppliers. For example, if you are an apparel store, your Chinese manufacturer or supplier may charge a little less than your Indian supplier.
In such scenarios, you have to consider the varying costs when calculating CLV for these product purchases. But, it’s not as simple as:
(Product Price - Varying Product Costs) * Number of Purchases.
The best way to accurately calculate CLV, when you have varying costs, is by doing the calculation on a spreadsheet. In fact, using spreadsheets is the ideal way to calculate CLV at any time, if you’re not using an analytics app.
So, for this example, we’ve used a constant product (retail) price of $10 but varying COGS.
Here’s the result:
As you can see, the product costs are varying for almost every purchase made each month.
That results in a gross profit which is also varying for each purchase. It is determined by deducting varying product costs from the product price,
To find the lifetime value of the customer, we add the gross profit from month 1 through month 10. That gives us a cumulative LTV of $66.50 at the end of the 10th month.
Now, let’s dive into a little more complicated formulas and calculations, starting with the addition of Churn rate to the equation.
Customer Lifetime Value Formula With Churn Included
Every ecommerce store experiences customer churn. It means your customers stop buying from your store after a period of time, which is a common occurrence for various known or unknown reasons. And Churn or Retention (which is 1 - Churn) is a key metric that determines the profitability of an ecommerce store.
So, when calculating CLV, it is very important to consider the Churn rate or retention rate of your customers.
For example, if you have acquired 100 customers in the month of January, and 5% customers are leaving each month, what is the lifetime value of each customer by December?
To make this calculation, we will assume that the customer acquisition costs for the first month is $100. Now let’s calculate the lifetime value.
So, step 1 is to determine the gross profit. To do so we use the following formula:
Gross Profit = Revenue - Costs - CAC.
Step 2, assuming a churn rate of 5% each month, we calculate the weighted average GP.
Weighted Average Gross Profit = Gross Profit * Retention Rate
Step 3, we accumulate the gross profit from month 1 through month 12, which gives us the cumulative LTV of $1,847.93.
This is the LTV of all the customers acquired in month 1 after the given time period. But what is the lifetime value of each customer acquired?
That gives us step 4,
Per Customer LTV = Cumulative LTV (with Churn included) / Total Customers Acquired at Beginning of The Time Period.
We have acquired 100 customers on month 1, so that gives us a customer lifetime value of $18.48.
Customer Lifetime Value Formula With Discount Rate
So, we now know the formulas or the ways to calculate CLV with Product Costs, Acquisition Costs, and Retention Rate included. Now let’s look at one more variation of the original formula with discount rates added.
Discount rate, in its simplest terms, assumes that over a longer period of time (say 5 - 10 years) that your customers will start to buy less from you or completely stop buying from you. In other words, it's an assumption about the future value of your current payments/investments.
Companies generally use Weighted Average Cost of Capital (WACC) to find the discount rate.
To keep it simple, we will assume that the discount rate is 20% each year and for the purpose of this calculation, we will spread the discount over 12 months.
To do that, we use the formula,
(1+annual discount rate/12) ^ (month - 1).
Here’s what the calculation would look like:
With retention rate consistent at 95% after month 1 and a CAC of $20 on the first month, we get a cumulative lifetime value of $39.46, after considering the discount rate of 20% per annum.
These are the multiple variants of the basic formula that are commonly used formulas across small to medium ecommerce stores.
Now let's look at two different versions of the CLV formula, an advanced formula and a predictive formula.
Advanced Customer Lifetime Value Formula
The advanced formula or equation to calculate CLV is as follows:
Source: CLV Equation by Geoff Fripp
This formula helps calculate the customer lifetime value by accounting revenue, costs, retention, discount, and acquisition costs.
To explain the formula,
CRn represents Revenue
Cn represents Product Costs
Rn represents Retention Rate
D represents Discount Rate
AC represents Acquisition Costs
Σ represents the sum of the CLV for a period of n years.
Let’s look at this calculation with some numbers.
Imagine a customer A has been doing business with you for the last 5 years. We will consider year 1 revenue as $1,000 and then a churn rate of 25% & a discounted rate of 10% each year. We also add customer acquisition costs for the first year.
Here’s what you get when you calculate:
So the cumulative LTV of the customer over the period of 5 years is $1,004.45.
Customer Lifetime Value Formula - For Predicting CLV
The one characteristic that differs CLV from other customer retention metrics is its ability to predict future customer purchase behavior. If not for that, traditional methods such as RFM (Recency, Frequency, Monetary Value) approach or PCV (Past Customer Value) approach to understand customer retention would suffice businesses.
One of the common formulas used to predict or calculate expected CLV is as follows:
Here,
N stands for Net Revenue after all costs
R Stands for Retention Rate
D stands for Discount Rate
Let’s assume that in a given time period, the net revenue of the customer is $1000, retention rate is 60% and discount rate is 25%.
Here’s what we get as expected CLV when we factor in the above numbers.
That results in an expected CLV of $923.08
So, if the time period we accounted for is year 1, then in the following year (assuming the customer behavior, retention rate, and discount rate remains consistent) the expected CLV will be as the above.
However, it is important to remember that in real-time various factors can lead to changes in customer purchase behavior.
For example, most consumers became dormant during the initial periods of pandemic, resulting in huge losses for some businesses. On the flipside, some ecommerce businesses had unprecedented growth. So we cannot always predict market scenarios accurately and therefore, expected CLV should be carefully accounted for.
These are all the various formulas that you can use to calculate customer lifetime value of your ecommerce business.
You can also download our Free CLV Template For Ecommerce Businesses.
Use Bloom Analytics To Accurately Calculate Your Customer Lifetime Value For Your Shopify Business
Ecommerce is a tough business and if you’re a Shopify merchant then you know that the struggle is VERY real.!
But that should not be an excuse to give up on finding important insights of your business metrics. Like lifetime value, there are other important metrics such as customer acquisition costs, revenue, gross profit, net profit, cost of goods sold and more.
And you should track all these metrics, without fail.
However, we understand that it is extremely difficult to put all the various metrics together and formulate them on an excel or spreadsheet.
So let us help you in finding granular insights into each of these metrics and in the process, make it a super easy and stress free task.
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Frequently Asked Questions (FAQs)
What is the customer lifetime value?
Customer lifetime value is the total financial contribution made by a customer over their lifetime with your business. It’s a critical metric used to find ideal customers, predict future profitability of your store, and to understand customer behavior.
You can learn more about it here: What is lifetime value?
What is lifetime value calculation?
Lifetime value calculation is the process of finding your customer lifetime value over a period of time, by using various metrics such as revenue, product costs, retention, acquisition costs, and discount rate.
Here’s a free CLV calculator that you can use.
What is the customer lifetime value formula in excel?
The basic formula that you can use to calculate CLV in excel is CLV = (Product Price - Product Costs) * Number of Customer Purchases.
The other variant of this formula is CLV = (average order value - average product costs) * number of customer purchases
But you should consider other key inputs. Here’s a CLV Excel Template that can help you.
What is the customer lifetime value formula in marketing?
To calculate customer lifetime value in marketing, you have to use the following steps:
Step 1: Find the lifetime revenue of the cohort of customers:
Lifetime Revenue = (Revenue – Product Costs – CAC – Handling Costs) * number of purchases.
Step 2: Find the cumulative LTV, which is a combination of lifetime revenue over the mentioned time period.
Cumulative LTV = month 0 + month 1 + month 2 + …. + month n
Step 3: Finally, to find per customer lifetime value.
Per customer lifetime value = Cumulative CLV/Number of Customers
Here’s an example:
How do you calculate the lifetime value of a customer in excel?
In our guide to customer lifetime value, we have covered the step by step process on how to calculate lifetime value in Excel.
And here’s the excel template for CLV that you can download.
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