You’ve probably noticed the acronym LTV (which stands for lifetime value of a customer) comes up frequently within the ecommerce space. There’s a reason for that. A study conducted on top-performing businesses found that on average, the LTV of those top businesses was five times higher than other companies.
These companies are clearly onto something by focusing on driving up their LTV. But...how? And why?
Most ecommerce merchants have a basic understanding of what LTV is, but we’re here to go deep and talk about why it’s so important to an ecommerce business, how to calculate it, and how to effectively utilize it to increase the profitability of an ecommerce operation.
LTV: What is it?
LTV is defined as the lifetime value of a customer (sometimes called CLV or CLTV). LTV is a key performance indicator tied to the total amount of money a customer brings to a business over their lifetime. From a zoomed out perspective, LTV can illustrate how much a customer is worth to a brand, offering unparalleled insight into their overall value.
Once you access this number, you’ll have a better understanding of where you should invest to increase customer retention moving forward. To put it into perspective, the top 1% of ecommerce customers can be worth up to 18 times more than the average customer. Customer value is not the same across the board, and knowing your LTV will help you narrow down which ones are the most valuable to you.
Furthermore, LTV offers insight into which customers you can expect to become repeat customers. Those with a higher LTV are likely fans of your company and will continue to purchase products from you, while those with a lower LTV are more likely to be one-time purchasers.
Calculating the LTV on Shopify
While the process of calculating LTV is more complicated than the formula makes it seem, the concept of it is straightforward: To calculate LTV, take the gross profit per order and multiply that by the lifetime orders per customer. As an equation, it looks like this:
LTV = Average net revenues per order x Average # of orders x Customer lifespan
Now, you might be thinking: what does ‘lifetime’ refer to?
The answer is: it varies.
For early-stage brands that don’t have much historical data, LTV can be calculated on a shorter timeframe. Generally speaking, however, a customer's lifetime value is calculated over a time period of two to three years.
LTV to CAC: The key ratio for a thriving business
You can’t talk about LTV without talking about CAC (customer acquisition rate).
CAC refers to the amount of money it costs to get a customer to purchase a product. For a business to be successful (i.e., to make more money than it spends) the LTV must be higher than the CAC.
Ideally, a healthy LTV:CAC ratio will be at least 3:1. This means that the value of your customer should be three times more than it costs to acquire them. If the customer is only making you as much as you’re paying to acquire them (a 1:1 ratio), then your spend rate is too high.
Converting the customer: ad spend
Knowing this data and analyzing it properly can give brands a better sense of what kind of money they should be spending on advertising.
If you know what your customers spend per year on your brand, you can estimate more accurately how much you should spend converting them to purchase. LTV will also show you which customers to focus on and why.
For example: if you find your LTV is low, it might be a sign to focus more on increasing your retention rate and average order value rather than investing in more expensive conversion ads. On the other hand, if your LTV is high, it gives you the flexibility to spend more on customer acquisition.
Why is LTV so important?
While it’s necessary to keep track of daily sales and revenue, these metrics don’t provide more than a single snapshot of business performance.
To understand what’s really going on with customer trends, you need to look deeper. LTV is an incredible metric that can help predict your business’s future success and help companies understand the true value of its customers.
So why is the value of your customer necessary to know? One word: retention.
“An ongoing relationship with your customer makes 10-100xing LTV over time very doable.”
-Austin Rief, Founder of Morning Brew
Long-term business sustainability is all about getting repeat customers in place.
The aforementioned study found that by their second year, the top-performing businesses were earning over half their revenue from repeat customers. That means there’s a lot more value in repeat customers than in those who only purchase once.
Remember: The most valuable customers for any business spend up to 30x more than an average customer.
If you want your ecommerce business to succeed for the long haul, knowing how much your customers are worth is critical.
It’s a good idea to keep track of your LTV as part of this, as if you don’t pay attention to it, you’ll likely miss out on long-term growth opportunities (because LTV clues you into the big picture). Not monitoring your LTV can ultimately lead to wasting time and money on customers who don’t bring in as much revenue as others.
The lesson here is: increase your retention rate and use insights from your LTV to figure out how to do it.
Calculating the LTV of Shopify brands with Polar Analytics
While the formula makes LTV seem simple, it can be a complicated and time-consuming metric to calculate when you don’t have an on-call data analyst.
This is why utilizing technology that brings all your data together and analyzes it can be extremely helpful. It’s exactly what Polar Analytics does as a full-stack business intelligence tool.
Not your average B2B SaaS company, Polar Analytics has an expert understanding of how ecommerce works. The platform was built from a marketer’s perspective and is focused on providing a place where all data can live for quick assessment and expert analysis.
Seamlessly combining data from platforms like Shopify, Recharge, GA, Facebook Ads and Klaviyo, Polar Analytics provides the essential dashboard tool for DTC marketers who want to make time-conscious, money-conscious and data-driven decisions. And among the many things you can monitor closely with Polar Analytics, one of them is LTV.
Polar Analytics provides a close look at LTV, giving brands the ability to filter based on qualifiers like first product purchased, first collection, or month of acquisition.
Measuring and improving retention with Polar Analytics
We all know there is a never-ending amount of data to collect. Collecting data isn’t often the problem, though. The difficulty is in drawing actionable insights from all that data.
This is where Polar Analytics comes in, automatically calculating your customer LTV once you connect your Shopify account (as seen above and below), along with identifying improvements with retention or specific issues with retention.
By comparing customer purchase history with customer LTV, Polar Analytics pinpoints which products are driving customer loyalty and leading to repeat purchases and which ones aren’t.
Utilizing this information will improve your business’s retention and LTV, helping you hone in on what products and customers to focus on as well as where any problems might be—ultimately giving you a deeper understanding of your company’s present and future profitability.
Optimizing your ecommerce business via insights into LTV with Polar Analytics
By now, you’ve got a good idea of what LTV is, why keeping track of it is essential to the health of your ecommerce business, how Polar Analytics helps calculate it, and how to use it to optimize your marketing efforts with the information it provides.
While cliché to say, time is money, and Polar Analytics helps you save yours and grow your business at the same time. Ringing in at a lower cost than other marketing dashboards and data analysts, Polar Analytics also offers a free demo for the curious.
At the end of the day, growing a business is about knowing your customers through and through. The comprehensive insight and overview LTV provides regarding customer behavior is one of the most solid customer metrics that exist for ecommerce business owners.