The aim of calculating CLTV is in the context of the costs of acquiring new customers. A marketing campaign, for example running television ads for a fixed time, may have a fixed cost upfront. The estimated cost of acquisition per customer for a television campaign that costs $1 000,000 and brings in 25 000 customers would be $40 per customer. If there is a lower than expected response to the campaign and only 20 000 customers are brought on, then the acquisition cost per customer rises to $50. Such is the nature of uncertainty of customer acquisition costs. Similarly, online marketing campaigns, like those on social media or google typically have fixed costs per view or click – say $0.20 for a view and an additional $0.30 for a click. However, not all people who click through to a company’s landing page will make a purchase. If only 100 000 customers view an ad, yet only 2% click through to the landing page and only half of new customers who click an online ad sign up as a customer of the business, the cost of acquisition is as follows:
Total cost: (100 000 people X $0.20 per view) + (2000 people X $0.30 per click) = $20 600
New customers: 20 000 clicks X 50% sign up = 1 000 new customers
Cost of acquisition per customer = $20 600 / 1 000 = $20.60
With cost of acquisition established, only the present value of all expected purchases would then be compared to the cost of acquisition. For known average customer life times, the customer lifetime values are calculated using the present values of expected net margins. For the earlier example with a discount rate of 10%, CLTV would be the sum of discounted net margins for the duration of the expected life time i.e. 3 years:
Year 1: $36 X 90%
Year 2: $36 X 90% X 90%
Year 3: $36 X 90% X 90% etc.
If customer retention is used there is an additional calculation. There is no fixed time limit but retention rates are factored in. In this case, it would be:
Year 1: $36 X 80% (retention rate) X 90% OR $36 X 72%
Year 2: $36 X 72% X 72% and so on
The present value is calculated using a perpetuity formula.
In order to improve the standing of a startup, the decision makers should focus on their most valuable customers using CLTV as a metric in conjunction with cost of acquisition. Additionally, they should aim to retain the most valuable customers.