Customer Lifetime Value: How To Calculate It For Your eCommerce
Table of Contents
How to measure the success of an eCommerce?
Focusing on indicators such as sales and revenue is useful for tracking the short-term performance of campaigns and content, but more is needed to lead to a complete picture of a business. Especially the future of that business.
What is Customer Lifetime Value?
Customer Lifetime Value is one of the most important factors in determining the success of your current and future business. It is an indicator that can accurately predict how much customers are really worth.
How? By measuring the predictable net profit that will be obtained throughout the entire relationship with a customer based on their buying behavior.
The success of E-Commerce does not lie in always finding new customers but in focusing on the right ones.
Because it’s important?
“Not all customers are the same.” Very often, in fact, 1% of eCommerce customers are worth much more than the remaining 99%. For this, we need to use the Customer Lifetime Value to know, and predict, the behavior of these customers: when and how much they will buy and when they will stop buying.
In this way, knowing how much value a customer can bring to their business in the long term will make it clear which customers to focus on, why they focus on them, and with which actions.
How do segment customers know their Customer Value?
Before calculating the Customer Lifetime Value, three fundamental factors must be considered to segment one’s customer base and subsequently calculate the Customer Value.
Recency: The last time a customer made a purchase. A recently purchased customer will be more likely to repeat the purchase than a customer who has not made purchases in a long time.
Frequency: How many times a customer has made a purchase in a given period of time. A customer who buys often is more likely to pay back than a customer who purchases infrequently.
Monetary value: the amount that a customer spends over a given period of time. A customer who makes major purchases is more likely to return to purchase than a customer who spends less.
As a matter of convenience, we use a scale from 1 to 3 (where 1 is the lowest value and three is the highest) to order more simply:
The success of eCommerce does not lie in always finding new customers but in focusing on the right ones.
How to calculate the Customer’s Lifetime Value?
Once the customers have been segmented based on the RFM method (Recency, Frequency, and Monetary Value), it is possible to proceed to calculate the Customer Lifetime Value of each segment obtained. To do this, you need three key indicators:
Average Order Value: The average of how much a customer spends each time they place an order. To get it, just divide the total sales by the total number of orders.
Purchase frequency: The average quantity of orders placed by each customer. Using the same time span as the average order value, divide the total number of orders by the total number of unique customers.
Customer Value: The average monetary value that a customer brings to a business over a given period of time. To calculate it, you need to multiply the order value’s average by the purchase frequency.
Once the Customer Value has been calculated for each segment of the customer base, to calculate the Customer Lifetime Value, multiply the Customer Value by the average lifespan of a customer. In other words, how long the relationship with a customer lasts on average before he becomes “inactive”; that is, he definitively stops making purchases.
In short, the success of an online business does not lie in “finding customers” but in “finding the right ones.” And thanks to this indicator, you will be able to make orders in your customer base and target specific target campaigns that capture those right customers. The ones that can really make a difference to a business’s profit.