Rob Dennis | 25 October 2024

When running paid media campaigns, it’s all too easy to get fixated on the cost per acquisition (CPA) figure. While this metric is important, focusing solely on CPA can mean missing the bigger picture. To truly understand the effectiveness of your paid media efforts, it’s essential to look beyond the immediate acquisition costs and consider the long-term value each customer brings to your business. Customer Lifetime Value (LTV) offers a more holistic view, allowing you to balance short-term wins with long-term growth, and to make informed decisions on how aggressively to acquire new customers while ensuring profitability over time.

Customer Lifetime Value (LTV) is the total revenue a business can expect to generate from a single customer throughout its relationship with a company. It looks beyond the initial acquisition of that customer and helps businesses account for repeat purchases over several months and years.

The best starting point to calculate LTV is with the average for your entire customer base, as you’ll have the foundation to compare the value of other cohorts you investigate.

To calculate LTV, analyse how many customers you acquired in the past year, their average order value, purchase frequency, retention rate and the margin you want to allocate towards these customers. See below for an example:

Example Customer Profile

New Customers In Year 1	10,000
Margin	20%
AOV	£100
Order Frequency	3
Retention Rate	80%

This is then fed into understanding how valuable a customer is over time; typically 5 years. To understand the below table, we’re assuming customer retention rate remains at a consistent 80% over these 5 years and that the average revenue per customer per year remains flat. A 10% discount rate is applied to indicate a loss in the purchasing power of the money in year 1.

To help with understanding the assumptions used in the table, it is assumed that 60% of the product price accounts for your costs, 20% of that price is the profit contribution and the final 20% is the maximum acquisition cost for that product. However, these ratios can be adjusted to suit your business.

The retention rate is the inverse of your customer churn rate and calculates the percentage of customers that return after year 1. To calculate this for your business, follow the below formula:

((Customers at the end of the period – Customers acquired during the period)/Customers at the start of the period) * 100 = Retention rate.

The discount rate is an assumption based on the reduction of spending power from year 1. Typically this is assumed at 10%. This 10% is based on the preceding year rather than a flat 10%, so it’ll be 10% of 100%, 10% of 90% and so on.

To calculate the Net Present Value (NPV) Contribution, use the following formula:

Net Profit * Discount rate = NPV Contribution

Cumulative NPV contribution is calculated by compounding the NPV by year.

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Customer LTV based on NPV Contribution Over Time

Customers	Year 1	Year 2	Year 3	Year 4	Year 5
Retention rate	10,000	8,000	6,400	5,120	4,096
Average Revenue Per Annum	80%	80%	80%	80%	80%
Total Revenue	£300	£300	£300	£300	£300
Net Profit (20%)	£3,000,000	£2,400,000	£1,920,000	£1,536,000	£1,228,800
Discount Rate (10%)	100%	90%	81%	73%	66%
NPV Contribution	£600,000	£432,000	£311,040	£223,949	£161,243
Cumulative NPV Contribution	£600,000	£1,032,000	£1,343,040	£1,566,989	£1,728,232
Lifetime value at NPV	£60	£129	£210	£306	£422

As you can see, the LTV of your customers in year 1 will be just £60. However, by year 5, over 40% of these customers will have increased their lifetime value by over 600% to over £422. This knowledge is useful, as it can be used to inform your customer acquisition strategy.

For example, you could decide to be more aggressive in acquiring new customers by making a loss on the initial acquisition, with the knowledge that you’ll make a profit with their second purchase. Furthermore, it also enables you to put a monetary value on Customer Acquisition Cost (CAC) should you wish to use a target CPA approach.

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Beyond this, once you have your average LTV for your customers, you can segment this further based on the types of products purchased or other behaviours such as newsletter subscribers, seasonality (e.g. Christmas/Black Friday) or acquisition channel. This can then be used to identify those customers who will be the most valuable to your business and help you focus your efforts on acquiring more of these customers.

Summary

Understanding and leveraging Customer Lifetime Value is a game-changer for any business looking to optimise its paid media strategy. By focusing not only on immediate acquisition costs but also on the potential long-term revenue from each customer, you can create a smarter and more sustainable approach to customer acquisition. If you’re unsure whether your current campaigns are maximising their potential, why not start with a PPC audit?

At WebBox, we can help you gain insights into your paid media performance and identify areas for improvement to ensure that every pound spent delivers results both now and in the future.