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Bool: What is Lifetime Value (LTV) & How is it Calculated?

What is Lifetime Value (LTV) & How is it Calculated?

User Lifetime Value (LTV) is a measurement used in the world of online marketing to determine the approximate revenue a customer will generate during their lifespan.  LTV is often used to help with decision making regarding marketing budget and to calculate both real and projected profitability.  Calculating LTV can be done using a variety of formulas, the simplest way is outlined below.

LTV = ARPU / User Churn

*ARPU = Average Revenue per User

How Lifetime Value is Used:

In-bound marketing teams tasked with attracting quality traffic create campaigns where they track performance (the number of impressions, clicks, registrations and finally purchases). Campaign types vary from keywords, email blasts, banner ads, etc. Existing paying users are also targeted by campaigns, however, for the purpose of this article we are excluding them.

To measure the effectivity of the aforenoted marketing campaigns, LTV is employed on a campaign level.  From here, marketing professionals can see which of their efforts were effective and which were not, making it easier to optimize their efforts. Furthermore, paying users can be grouped into segments based on a variety of factors and by tracking their original campaign and marketing channel costs, revenue predictions can be made on potential future users helping companies forecast growth.

As the paying userbase grows the average LTV will change, but as company growth starts to slow, LTV will stabilize.

While LTV is a great tool it is often used incorrectly for those looking to optimize the performance of their marketing teams.  Keep reading to discover the 3 main reasons why LTV is ineffective on its own.

 

Top 3 Reasons Why Lifetime Value is Not the Answer to Everything:

 

1. On its Own High LTV Does Not Equal Success

When using LTV as a metric to measure inbound traffic quality it is imperative to partner the LTV result with campaign ROI. By excluding ROI from the picture, marketing performance is not accurately depicted, and results can appear much better than reality.

 

Bool - LTV does not equal growth chart

 

For the purposes of analyzing the above chart, only the in-bound marketing team efforts are being taken into consideration and all CRM efforts that could otherwise be taken into consideration are excluded. When only taking LTV into consideration, the in-bound marketing team should work to acquire more users like Jack and Joe.  However, when ROI is added to the picture it becomes clear that Jane is the clear winner and acquiring users like Joe will lead to losses.  While there may only be 3 users on the chart, examining internal data will show that most in-bound traffic will fall under one of the three user types listed above.

 

2. LTV Should Not be Used as a KPI for CRM (Customer Retention Management) Professionals:

Customer Retention Management focuses on how to retain as many paying users as possible as well as convert as many leads into paying clients. Simple right?  Not at all, reason being Customer Retention departments tend to fall under marketing in the corporate organizational structure where LTV performance is often used to measure marketing success.

 

Instead of CRM professionals concentrating on extending the average life span of their users, they are tasked with satisfying the obsessive need to grow the average LTV often resulting in resentment between the CRM and in-bound marketing teams over the quality of traffic and who is to blame if targets are not met. Ironically, if LTV were taken out of the picture, overall revenue would be higher, as we see with Jane in the above chart.

 

3. LTV KPI’s are easily manipulated:

I do not condone statistical manipulation, nor do I feel it to be ethical when working to reach KPI’s, however, that does not mean that it cannot be easily done. Below are just two simplified examples regarding how LTV can be manipulated.

If being tasked to raise the average LTV from say $500 to $1000, you can do it simply by ceasing all marketing efforts on users driving the average down, such as Jane in the above chart, and concentrating on the higher echelons, such as Jack.  To cloak your efforts so as not to be obvious, you will target your lower value users on a low flame, such as Joe.

 

The average KPI will certainly go up and the CRM professional is likely to meet their targets with little effort, however, the churn rate will increase for a time.  But if the priority was to increase LTV you have done it and you can always blame the in-bound marketing team for driving low quality traffic, right?

 

On the flip side, in-bound marketing teams can run extremely targeted campaigns to bring big short-term spenders, such as Jack, which will drive up the average LTV on their side. Since the new customer was targeted with the intention of them being short term, the campaign LTV is high but so is the churn rate and potentially not ROI positive.

 

In both scenarios there is no winner and certainly neither provide stability conducive to growth.  While LTV is an interesting tool, it should not be used as a KPI to measure campaign performance on its own let alone team performance.

 

For more balanced and accurate ways of defining and measuring success, Bool is here to help.  Contact me at: dara@boolbiz.com to discuss your business and how we can help make it grow.

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