CHAPTER 2: Part 1
A Deep Dive Into Customer Lifetime Value
Lifetime Value (LTV) is a very important metric for the success of a subscription business. Some in the subscription eCommerce industry may even call it the “Holy Grail” of metrics. Why is that? Because unlike one-time sale business models where customers are buyin a single t-shirt or char, many growth strategies in the subscription business rely on discounting the initial offer with the anticipation of gaining long-term and high-value customers due to recurring charges. While most companies know that LTV is important, many only look at this metric as a snapshot for the success of the business. We want to not only be able to say that our return on investment for new user acquisition is positive, but we also want to show that we’re profitable after considering all of our costs.
Before we go any further let’s talk about why it’s difficult to calculate. In short, LTV is complicated because of disjointed data. The eCommerce tech stack requires at least a storefront, a billing solution and often a different billing component or app to schedule recurring billing. This means that each time a person makes a purchase, data records are created in multiple places, and rarely is there a true singular customer view aggregating the total earned revenue of an individual subscriber. Without using a comprehensive billing and analytics tool, such as Sublytics, brands may not have a central place to see the aggregation of one-time sales, subscriptions and add-ons. Therefore, the mistake can be made to not attribute all of the revenue earned for a single customer, which may make a customer’s LTV look deflated. Learn more about defining an active subscriber in our chapter on retention.
So now that we know why it is difficult to calculate customer lifetime value, let’s review the simplest formula to be used as a snapshot for LTV:
Lifetime Value = Total Revenue / Total Customers
When determinging what your revenue metric is in this formula, make sure you are aligned with your stakeholders. Some companies use Gross Revenue while others use Net Revenue. Net Revenue can be calculated differently depending on the company, so be sure to align this definition with the rest of your financial statements.
For this example and the rest of this chapter we will be speaking in terms of Net Revenue. Net Revenue also takes into account costs, which will give you and your stakeholders a better sense of the impact to your bottom line.
Lifetime Value = (Total Net Revenue / Total Customers) For a Given Time Period
Example:
Lifetime Value = ($900,000/ 500 Total Customers) For the Month of April = an Average LTV of $1,800
This formula is inflated. Here is why. When looking at 500 total customers for the month of April, some are in their first month of their subscription and others could be on their last, meaning they have had more time to mature and accumulate revenue for your company.
This is all to say that you wouldn’t want to build out a forecasting model based on the $1,800 LTV without applying your Average Retention Rate to the snapshot formula below.
Lifetime Value = (Total Net Revenue / Total Customers) * Average Retention Rate
Example:
Lifetime Value = ($900,000 / 500 Total Customers) * 65% = $1,170
For many new subscription businesses it can be hard to determine their Average Retention Rate, since their customer’s “lifetime” has not had time to fully mature. Fortunately, there is a very clear way to determine when you can start relying on this metric as a foundational value in your LTV formula.
How to Analyze:
Leveraging a customer LTV trend graph organized by customer acquisition date, you are able to easily visualize where the slope of accumulated net revenue begins to plateau.
As you can see in this example, the slope of Net Revenue starts to flatten between August and September. The plateau of the slope means that your growth is stabilizing once subscribers reach their fifth month, and you can now depend on the data maturity across customers within that cohort.
Many new subscription businesses need to take some calculated risks when establishing an initial acquisition program, meaning how much are they willing to spend to acquire subscribers whose customer lifetime value is not yet known. If you're creating your initial media waterfall, be conservative with your Average Retention Rate metric and assume somewhere between 55 to 65%.
While many analytics companies recommend using snapshot calculations to define LTV, we find that it’s much more impactful to group customers into cohorts by acquisition month to account for different maturity timelines.
As we dive further into details on the role LTV plays in acquisition in Part II, we will keep this base-level filter of acquisition month before further analyzing LTV by acquisition source, campaign, medium, etc. We will walk you through how to handle analying cohorts considering maturity in Part II, as well.
Avoid Common Mistakes When Analyzing LTV:
Assuming longer lifetime values and retention rates.
When subscription brands are just getting started, many are tempted to estimate a lifetime of 12 months with consistent monthly charges or ideal retention rates of over 90%, when in reality the industry average is closer to three months lifetime and 65 to 75% retention rate for subscription eCommerce.
Not considering costs.
When you calculate LTV with Gross Revenue rather than Net Revenue, you are leaving out a big piece of the picture, which takes into account product and operating costs and is a better view into your bottom line.
What's Next?
Subscribe to our newsletter below to learn more about how to use your customer lifetime value metrics to impact profitable business decisions such as:
How to use LTV in determining your acquisition targets.
Understanding how customer behavior impacts LTV.
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Up Next: The Essential Subscription Data Guide Chapter 2.2 – Lifetime Value in Acquisition
