And, worst case scenario, it can lead to your business’ bankruptcy.
But there's a simpler and more actionable way to measure this key number.
Let me explain.
The Problem with Our Current Understanding of LTV
The business world is full of heuristics or rules of thumb.
Some are useful like "niche down to scale up" or "focus on benefits, not features".
But some are so general that end up being misleading.
One of the surrounds LTV and it says something like
" If your LTV to CAC ratio is bigger than 3, you are good to go."
In other words, if your customer produces 3 times more money than what it costs to get it, you have a good business.
This might make sense for VC-backed SaaS. They don't have variable costs nor an immediate need for cash.
But for most eCommerce businesses, this is not the case:
Many are self-founded and can't wait a year for the customer to return and pay back the acquisition costs.
SaaS has almost 0 marginal costs. E-commerce, on the other hand, needs money to produce more units, store, and ship them.
If we follow this 3:1 rule, we will likely end up with a cashflow-negative business that is on the way to bankruptcy.
A ecom brand that:
Acquires customers for $15
Has a First-Order AOV of $20 that costs $10 to produce
And an LTV of $45 that takes one year to realize
They either have cash sitting around to support the initial loss or are blind to what's happening.
What's the alternative then?
Glad you asked!
A New Way of Thinking About LTV
If we propose a new way of thinking about LTV, it should have the following characteristics:
Take into account variable costs
Have specific time periods
Actionable
Considering Variable Costs
SaaS and eCom are completely different businesses.
The former has almost 0 variable costs apart from marketing. The latter needs to produce, ship, store, etc.
So, let's make a distinction between revenue and value.
Revenue is the total amount earned.
Value is Revenue - Variable Costs (Cost of Goods Sold + Shipping)
We could call it Profit or Contribution Margin, but we'll keep it simple and not add a new definition.
So, from now on, LTV, refers to money that is left after considering variable costs.
If a customer has generated $100 of revenue in a year
And we know 50% of it is variable cost
Then, according to our new definition, the customer has an LTV of $50
Considering Time Periods
A year might be too long for many brands, so we need a shorter time frame to make it actionable.
To solve this issue, we will add a component to the LTV metric that refers to the period we are considering. For example:
60-Day LTV is the profit the customer produces 60 days after acquisition
120-Day LTV is the profit the customer produces 120 days after acquisition
1-Year LTV is the profit the customer produces 365 days after acquisition
1+-Year LTV is the profit the customer produces 2/3 years after acquisition
In this way, we can measure and improve them through different strategies.
Benefits of This New LTV Paradigm
After I started thinking of LTV this way, I understood the businesses I was working with, more holistically.
How much we made on the first order was just one piece of the puzzle.
If our 60-Day & 1-Year LTV was solid and had the cashflow to sustain it, we could aim for breakeven on first order.
If I detected a very poor 60-Day LTV, we either were on a one-time purchase business or had a huge growth lever to pull.
Apart from the conceptual change that it brought, here are some other benefits:
It's actionable: We can run tests to measure the increase in 60-Day LTV without relying on proxy metrics like email open rates or NPS.
It's flexible: 60-Days is too short of a time for you? No problem, you can start tracking 90-Day, 120-Day LTV, or even 169-Day LTV.
It's closer to cash: By subtracting variable costs, we can see clearer if we are making money or not. As a rule of thumb, the closer we are to "cash in the bank", the better our decisions will be for the business.
5 Ways to Improve LTV
Here are some elements you can experiment with to improve your LTV:
Offering subscriptions: This is the holy grail of LTV improvement. If your product has a recurring nature, offering a subscription option is a must. It's the best way to ensure that your customer will buy again and again, without any effort on their part. Just be careful, don't push it too hard or visitors will notice and your credibility will diminish.
Optimizing your Post-Purchase flows: I've seen it again and again. The month customers buy more after the first order is Month 0, the same month they made the purchase. Still, many eCom brands don't have a powerful post-purchase flow (email and SMS). Don't underestimate it, it's a powerful tool in your growth arsenal.
Upselling and cross-selling: No, I'm not talking about the usual recommended products below the fold on PDP. After the purchase, customers are still engaging with your brand through the Thank You Page, Account Page, Track Order, etc. Leverage this real estate to sell them complementary products based on their purchase.
Creating new flows: Understand what is the average time your buyers come back for more and create timely flows. If you detect that a percentage of customers buy for a second time 75 days after the first one, create sequences that make them fall in love with your brand again.
Introducing new ways of communicating: Email is not the only way brands have to speak to their customers. Think outside the box and test different channels like SMS, push notifications, FB communities, apps, etc. Ideally, you should measure the incremental impact of these channels, not just attributed revenue, since the cost could outweigh the benefits.
Improve the unboxing experience: This is your customer's first real interaction with the client, so make sure it's perfect. A good unboxing experience improves your brand perception and is likely to increase retention rates.
Developing membership or affiliate programs: These are great tactics to keep your customers coming back. You might not be able to build a membership program like Starbucks, but dozens of apps can do the job. Again, make sure to test them and ensure they are driving incremental revenue!
Conclusion
There you have it. A new way (or a more refined way at least) of thinking about LTV.
I've said it a couple of times through the post, but it's worth repeating:
IF YOU HAVE THE VOLUME, EXPERIMENT EVERY CHANGE YOU INTRODUCE.
A/B Testing is an amazing tool to understand their impact and enables you to keep only the positive ones.
If not, you run the risk of implementing strategies that hurt the bottom line in the long term.
And, of course, if you need help building your experimentation program, contact us. We can help.
