In business, customer lifetime value or lifetime customer value is a statistical calculation of the net profit at the end of any one-year relationship. Customer lifetime value is often quoted as the average life-time profit of a customer. This is usually expressed as a percentage of the total profit made by a company in a specific year. The larger the customer base, the larger the percentage and the more accurate the calculation will be.
There are several formulas used to determine the value of a customer. One is called the Present Value of a transaction or the Cost of a Transaction. The formula is expressed as the price to sell at the present time divided by the expected future cash flows for the same transaction. Another is the Total Revenue Formula whose purpose is to calculate the effect of adding one new customer during the existing customer lifetime on total revenue generated for that period of time. There is also the Time Value of Money Formula which was introduced by J.W. Watson in 1947.
These formulas were created so that the true worth of an entity could be determined. They take into consideration the present value of all future cash flows even though at the moment they are occurring. In other words, what is the best value for the present? How would you value a future payment today? The formula then Divide the Present Value of a transaction by its Total revenues to get the Customer Lifetime Value.
One very important component of customer lifetime value is referred to as the Metric of Loyalty. This is also known as a loyalty Scorecard. This metric is calculated as a ratio comparing the total revenue of a company with their number of loyal customers. So if a company has a low loyalty scorecard then they should expect that their sales would be lower than a company who has a high loyalty scorecard.
The third important concept that can be used in measuring customer lifetime value is the Return on Investment (ROI). The ROI is a monetary value that represents how much it costs to provide a product or service to a customer. It is also calculated by dividing the total revenue by the total cost incurred. The concept of ROI is directly related to customer retention because it shows if the company invested in training, advertisements or other means of increasing customer loyalty and returns on their investments.
These concepts presented above are just a few of the many different ecommerce metrics available. There are still many other valuable concepts that have yet to be discovered and measured. What is important is that a company uses a metric that helps determine both its short-term and long-term profitability. The more reliable the metric, the more likely it will be able to provide a good picture of a company’s ecommerce performance.