How Do You Calculate Lifetime Value?
Calculating lifetime value can be done in a variety of ways. When working with a subscription model, for example, a simple way to calculate the lifetime value of a customer is to take the average monthly amount expected from each customer and then divide it by your churn rate. A churn rate is a rate at which you lose customers each month.
For example, if you charge $200 per month and your churn rate is 2%, then your lifetime value for a brand new customer is 200/0.02, or $10,000. This means that a customer’s expected lifetime in this example value is 50 months, which equals to a little over 4 years.
So what about companies without a subscription model? In these cases, you look at the total income you expect to gain from a new customer and include everything from add-ons to upsells that you expect from the customer as well.
You can calculate this by multiplying the average order value (AOV) by the number of expected purchases and time of engagement. With this in mind, the lifetime value of a customer can actually increase or decrease over time depending on your company’s offerings and ability to grow the account.
When calculating lifetime value, you have to remember that your customers are real people, and people can be unpredictable. Different types of customers can have different lifetime values, especially when you consider that your business will have different pricing levels for your different product or service offerings. To make things a little easier, you should do your best to calculate the lifetime value of different customers based on the pricing segment they fall into.
For example, if you have three different levels of software packages that you offer, you must create a lifetime value based on the historical data of each level of software package. This will create three different lifetime value metrics that you can then use to calculate growth, retention rates over time, revenue forecasting, and more.