Customer Acquisition:
Calculating the Value and Worth of eCommerce Buyers
Summary
In the eCommerce industry, one metric is arguably more important than any other: customer lifetime value (CLTV). Without knowing a customer’s aggregate profit to your business over the lifetime of the relationship, it’s virtually impossible to calculate your marketing ROI.
Many data sets will get you closer. For example, Amazon Brand Analytics offers the Repeat Purchase Behavior report, which not only gives you insight into which products get purchased again and again, but also reveals your total number of customers. While this information is valuable, it is not enough to maximize profits.
To know how much you can afford to spend acquiring a new customer, you have to know their lifetime value. This post will explore how this metric can be used to maximize your customer value and acquisition spend.
why cltv matters
CLTV is a crucial metric for the following reasons:
- Knowing how much a customer is worth sheds light on the right amount you can/should spend to acquire them. This, then, allows you to more aggressively target customers, spending in full knowledge of what the return can be.
- CLTV provides clarity on which customer segments are most profitable, enabling you to prioritize spend and target those high-value buyers.
- CLTV helps you manage channel performance: with this calculation, you can understand which channels are providing the most valuable customers.
How Is CLTV Calculated?
The best way to calculate CLTV often depends on the data sets and analytics resources available to your business, as well as the products your business sells. Although CLTV formulas exist in much more complex iterations, there are two main approaches to calculating CLTV:
Simple CLTV Formula
This is the simple CLTV formula:
CLTV = time in years x annual profit - acquisition cost
This formula provides a quick and easy way to produce ballpark figures. To calculate it, you need three pieces of information:
- The initial cost of customer acquisition.
- The annual profit contribution per customer.
- The average customer retention rate.
Complete CLTV Formula
Here’s the complete CLTV formula:
CLTV = annual profit x customer retention rate - acquisition cost with each year adjusted by an appropriate discount rate
This formula is an extension of the simple formula and takes into account each year of customer revenues and costs on an individual basis, allowing for different numbers to be used each year. It also uses a discount rate to calculate present value.
Deciphering CLTV Data
Generating new customers is often the most expensive endeavor for an eCommerce business. The ability to calculate and interpret CLTV data allows your business to strike an ideal balance between customer acquisition and retention. When taking that into perspective, the following related metrics become highly valuable:
Customer Acquisition Cost
Customer acquisition cost refers to all of the expenses the company incurs to generate a purchase from a non-customer. In conjunction with CLTV, this metric provides enormous insight when determining how aggressively you can target new customers.
Customer Retention Cost
The marketing costs a company incurs to increase company loyalty and reduce brand-switching. A side-by-side analysis of customer retention cost and CLTV will help you decide how to appropriately allocate marketing funds between acquisition and retention.
Customer Equity
Customer equity is the sum of all the CLTVs for a company. You calculate it with a discount rate, which provides the total expected profitability of a customer base. This metric not only informs marketing budgets and direction, but can also entice additional investments.
Counting the Cost
After you know your CLTV, evaluating the efficacy of common practices in customer acquisition for e-Commerce gets a lot easier. For example, you are running a pay-per-click (PPC) advertising campaign and need to know if your are profitably acquiring a customer. You have calculated the following:
- Your annual profit from a customer is $1,000.
- Your customers stay with you for around four years.
- Your cost per acquisition is $1,500.
Using the simple CLTV formula (time in years x annual profit – acquisition cost), you determine that your CLTV is roughly $2,500. This tells us that for each customer that comes from this PPC campaign we can expect to make $2,500. It also tells us that we should increase the budget for this campaign as it is profitably acquiring new customers.