The Formulas Behind Customer Lifetime Value and Customer Acquisition Cost

The Formulas Behind Customer Lifetime Value and Customer Acquisition Cost

Not all customers are created equally, so why do we pay the same for acquisitions costs? The cost of customer acquisition is one of the most important metrics for an ecommerce business, besides the lifetime value of a customer. Simply, because your business needs to make money in order to survive. So why is customer lifetime value also important? Lifetime value will give you an estimate of repeated sells you can expect from a particular customer, which will help make an informed decision on how much you should really spend in “buying” that customer for your business. Knowing lifetime value will also allow you to budget campaigns and discount offers. This way you can avoid disappointing results of discounting when your ecommerce business needs the cash flow to survive.

A formula for Customer Lifetime Value

To calculate the customer lifetime value, you have to take some variables and constants into account. As Sailthru, the modern marketing expert mentions in this article, these are the variables to consider:

  • Customer Value / Week (a) – how much does a customer spend weekly in your shop?
  • Customer expenditures per visit (s) – how much are customers willing to pay each time they visit your shop?
  • The purchase cycle (c) – how often do customers visit your shop each week?

After calculating the variables, you will have to consider some constants to help you determine your estimated customer lifetime value. As SailThru describes, these are the constants to consider:

  • Average customer lifespan (t) – how long, based on your experience, do you expect customers to remain your customers?
  • Discount rate (i) – no, this is not your customer’s discount. You are projecting a value, into the future, but you’ll have to adapt this value to present tense. Simply put – the value of a certain good in the future is lower than that of one you are holding in your hands today. You can study more about this topic starting with the Annual Effective Discount rate and than heading over to Intertemporal Choice. Puzzled? Maybe you’ll want to go with something like a (0.1) value.
  • Customer retention rate (r) – how many of your customers come back to your store and purchase from you, compared to the previous, equal amount of time?
  • Profit margin (p) – pretty self-explainatory
  • Average Gross Margin per Customer Lifespan (m) – the gross profit per customer expected in the given average lifespan (Profit Margin x Expected customer lifetime expenditure)

Now that you have calculated the variables and constants, you can move on to three equations, as outlined by SailThru:
  1. Simple Customer Lifetime Value Formula 
    There are two main variables involved – the average customer value / week (a) and the average customer lifespan (t), expressed in years.

    The formula for Basic Customer Lifetime Value:

  2. Extended Customer Lifetime Value Formula
    Now, take into account our profit margin and double check the figures, by using the Customers expenditures per visit (s) and the Purchase cycle (c) value.

    The formula for extended customer lifetime value:

  3. Projected Customer Lifetime Value Formula
    This formula will calculate customer value using the Gross Margin per Customer Lifespan (m), discount rate (i), and retention rate (r).

    The formula for Projected Customer Lifetime Value:

Use the three formulas to find an average. Once you find that number you will know how much to spend on particular customers. Knowledge is key! Make sure to identify loyal customers. Separate customers into marketable groups to engage your profitable customers, and spend less on unprofitable customers.

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