Understanding how to calculate Life Time Value (LTV) of a customer is essential to knowing how to approach strategic decisions related to marketing. When a business has either a sporadic customer purchase cycle or a long term interval between repeat purchases it can be challenging to know what the LTV is. In this article we will explore how to make such a calculation.
Businesses like Sewell Auto Group and Park Place Auto Group work diligently at making each and every customer feel appreciated. They know that historically people buying an automobile have very little long term loyalty to the dealer and they know that if they can create repeat buyers out of their customer base it is one of the most cost effective marketing investments that they can make.
Real estate agents take the same approach. People used to only purchase a home about once every 6 years on average and that is a long time between sales. Since 2008 the average time between home purchases for single family buyers has increased to a little over 9 years. Because a fresh stream of Buyers and Sellers are notoriously difficult to find on a steady basis anything that a Real Estate Agent or Brokerage can do to increase repeat client business pays huge dividends long term.
Restaurants know that getting patrons to return is a lot less expensive than generating new patrons therefore they have loyalty programs and menu changes and email marketing campaigns to keep their existing customers returning more frequently.
All of these kinds of activities are done in an attempt to encourage repeat purchases and, if possible, decrease the time between those repeat purchases by existing customers. Understanding the mix of revenue stream options available impacts how to calculate life time value of a customer.
Lets consider Real Estate. In Collin County and Norther Dallas the average sale price of a home is about $500,000 and the Listing Agent gets 3%, or about $15,000, minus whatever cut they have to share with their brokerage, if any. If the average client sells their home once every 10 years and you get 2 chances to work with the average client during your career as an Agent, what is that client worth?
Using the Present Value formula you would determine the following:
- Present Value of the immediate Purchase = $15,000… because there is no time lapse between your marketing outlay and the commission that you earn. I am assuming that you list a home for sale and you sell it in a few short months.
- Present Value of the sale commission earned in 10 years. Assume a Bank APR rate of 8% as your discount rate and using the formula you find here: https://www.calculator.net/present-value-calculator.html … Value found = $8,375.92
- Total Present Value = $23,375.92
How much would you be willing to pay to generate a Present Value of $23,375.92?
There is no right or wrong answer to that question. Each person will likely have a different response.
I would answer the question this way… Since I would not be willing to wait for 10 years I would ignore the future payment and focus on the $15,000 and my answer would be that I would be willing to pay something in the range of $1,500 to $3,000 to earn $15,000. Of course, since a portion of that would have to be shared with my Broker I would adjust my thoughts accordingly.
Now let’s think about a car dealer. They have a different set of dynamics. When a car dealer sells a car they get ongoing revenue from service and parts sales. Maintenance, repairs, parts, all generate revenue for car dealers. Depending on the Dealer this can be significantly more than the profit that they make on the sale of the vehicle. A car dealer would need to analyze their average revenue stream related to such services and use either an average monthly number and the PVoA process, or create a spreadsheet and calculate the PV of each month’s projected revenue from the average customer and then use that come up with the LTV of the customer.
Understanding how to calculate life time value can be tricky. Each type of business needs to perform the LTV calculation slightly differently based on the mix of Recurring versus Non-Recurring revenue streams associated with each new customer.