Lifetime Value (LTV) is a measurement of a customer's long-term profitability. It is one of the most important calculations your company can make. It is the total profit that your company will receive from transactions with a given customer during the time that you continue to market to them. There are many ways to calculate Lifetime Value, but most are so complicated as to be unusable.
As an alternative, we calculate the estimated Lifetime Value to date. The formula we use is…
LTV = Monetary Value - (direct costs + indirect costs), where direct costs = (Monetary Value x 70%) and indirect costs = ((average Monetary Value x 20% ÷ average Tenure) x Tenure).
Note that direct sales costs are charged to individual customers in direct proportion to their Monetary Value at the rate of 70% of their individual sales. Indirect sales costs are charged to all customers equally at the rate of 20% of total sales prorated by their individual Tenure. Direct costs are those that apply only when a sale is made and include the cost of goods sold, sales commissions, customer service, and fulfillment. Indirect costs are those that apply whether a sale is made or not and include marketing and overhead.
Distributing costs in this manner causes some customers to show a positive LTV and others to show a negative LTV, but allows total LTV to equal 10% of total Monetary Value. This method of calculating LTV roughly equates to EBIT (earnings before interest and taxes), which for a typical b-to-b company ranges from 10 to 15 percent and for a typical b-to-c company ranges from 5 to 10 percent.
LTV can vary considerably among customer segments. It is a primary predictor of customer behavior, similar to Recency, Frequency, and Monetary Value. Negative LTV is an especially good predictor of future un-profitability. When customers produce a negative LTV, it means that their Monetary Value has been insufficient to cover their share of the indirect sales costs. In other words, they have low Recency, Frequency, and Monetary Value, but high Tenure. (Translation: they have been customers for a long time, but haven't bought much.) Customers with negative LTV, especially those in Life Stage Four, are very unlikely to become profitable in the future, and should be replaced.
Knowing the LTV of customers allows companies to decide how much they should spend on their Acquisition and Retention programs. LTV can also be used to identify the most valuable prospect lists, lead generation programs, promotional offers, product offerings, and markets. LTV is closely associated with Retention. A small boost in Retention can result in a large increase in LTV.
On this web site, the LTV is limited by the Analysis Period, which is determined by the dates of the sales transactions included in the Upload File. The Analysis Period has a direct bearing on LTV, in that it limits the "lifetime" to the period covered by the Upload File.