Shopify Customer Lifetime Value (LTV): A Comprehensive Guide
Many brands struggle to get meaningful numbers regarding customer lifetime value from Shopify. RetentionX is the easiest way to overcome this challenge.
CLV vs. LTV in E-commerce: In the realm of e-commerce, understanding the long-term value of a customer is essential. This value is often referred to as "Customer Lifetime Value", capturing the total worth of a customer to a business over the entirety of their relationship. Two abbreviations have emerged to represent this concept: CLV (Customer Lifetime Value) and LTV (Lifetime Value). Regardless of the abbreviation, the underlying concept remains the same.
Calculating the customer's Lifetime Value (LTV) not only detects the customers that are actually costing you money but also helps you determine which customers have the highest return on investment and what their common characteristics are.
- Predictive Tool: LTV allows companies to understand how much they should be willing to spend to acquire a new customer.
- Business Growth: Knowing the LTV helps in budgeting, marketing, and understanding customer behavior.
- Customer Segmentation: By segmenting customers based on their LTV, companies can craft personalized strategies to retain high-value customers and improve the value of lower-value segments.
– Shopify does not provide a reliable LTV metric out of the box
In eCommerce, LTV is the value that a customer will contribute to your company over their entire lifetime. Essentially, it is the amount of money that they will spend on your products after expenses.
Most tools and Shopify apps you can find neglect this factor and calculate the LTV only as the sum of the sales. But what do you gain from a customer who orders a lot, but sends everything back or only buys in sales at high discounts?
RetentionX recommends following LTV formula:
LTV = (AverageOrderValue x PurchaseFrequency) x GrossMargin
– within a certain time period.
But why is it important to consider the fixed time period? Quite simply, because otherwise you are comparing apples with pears. Customers you acquired 2 years ago had much longer time to build up high LTV values compared to new customers from the current month. To create fair conditions, you need to look at a period that all customers you base the calculation on have fulfilled. For example, LTV365, which measures the LTV of all customers who have been customers for a year from the time of the initial purchase to the 365th day after that purchase.
For this reason, it can quickly become complex to determine the correct LTV. RetentionX does it all out of the box - for all time periods, segments and dimensions. But more about that later.
So, since you have to look at each customer individually, the above formula is not really applicable. To calculate the LTV of each Shopify customer, we recommend the following formula:
LTV= ∑ Net revenue - ∑ COGS – in the given time period.
- ∑ Net revenue: Sum of all revenues after discounts, returns and taxes.
- ∑ COGS: All costs associated with these sales including purchase and production price of the items.
This will result in the real profit contribution of each individual customer.
But what if I don't want to wait a year to find out the LTV values of the Shopify customers I currently acquire? RetentionX has a solution for this as well: LTV predictions. With the help of the Prediction add-on RetentionX is able to assign an LTV value for all time periods to the customer already at the time of acquisition.
Prediction is performed via machine learning and searches data twins based on the following criteria:
- Purchase Frequency
- Product Preferences
- Average Order Value
- Return Behavior
- Order Quantity
The first step to dig deeper into the causes of your shopify customers' LTV is to look at the LTV cohort analysis.
Cohorts group customers by criteria. The default use case is to group customers into cohorts based on the month of their initial purchase. This allows you to analyze how customer quality has evolved over time.
It is important to monitor the LTV constantly. Many brands make the serious mistake of making assumptions about LTV based only on the oldest cohorts - their oldest customers. However, these are usually the most loyal by nature, as many are not acquired through performance marketing campaigns but consist of friends, acquaintances, employees and other overperforming segments. Since these also have the longest history, this data quickly distorts the overall picture.
The whole thing becomes problematic as soon as you combine the assumptions from old loyal cohorts with the growth from current new customer acquisition in order to justify high CACs (customer acquisition costs). However, since customer quality usually deteriorates significantly as a result of scaling, these customers will never reach the reference LTV values.
We have seen many brands get into trouble because of this misjudgement and have sunk millions into unprofitable marketing.
This analysis is also performed automatically for you in RetentionX.
Success hinges on a balance between acquiring new customers and maximizing their value over time. One key metric that plays a pivotal role in understanding this balance is the Customer Lifetime Value to Customer Acquisition Cost ratio (LTV:CAC). This ratio serves as a powerful tool for evaluating the efficiency and sustainability of a DTC ecommerce brand's growth strategy.
Understanding the Formula:The LTV:CAC ratio compares the value a customer brings to your business throughout their lifetime to the cost incurred in acquiring that customer. The formula for calculating this ratio is relatively straightforward:
LTV:CAC Ratio = Customer Lifetime Value (LTV) / Customer Acquisition Cost (CAC)
- Customer Lifetime Value (LTV) is the projected revenue a customer generates during their entire relationship with your brand. It takes into account factors like purchase frequency, average order value, and customer retention rate as well as costs.
- Customer Acquisition Cost (CAC) represents the expenses associated with acquiring a new customer. This includes marketing costs, advertising expenses, and any other investments aimed at bringing in new clientele.
- Ratio < 1.0: If the ratio is less than 1.0, it indicates that the cost of acquiring customers outweighs the value they bring over their lifetime. This could be a sign that the brand needs to reevaluate its acquisition channels, optimize marketing strategies, or focus on improving customer retention.
- Ratio = 1.0: A ratio of 1.0 suggests that the lifetime value of a customer is equal to the cost of acquiring that customer. While this may seem balanced, it's generally not enough to sustain long-term growth. Brands should aim for a ratio higher than 1.0 to ensure profitability and scalability.
- Ratio > 1.0: A ratio greater than 1.0 signifies that the customer's lifetime value is higher than the cost of acquisition. This is a positive indication that the brand is efficiently acquiring and retaining customers, which can contribute to sustainable growth and profitability.
- Optimized ROI (Return on Investment):By understanding the LTV of customers from different channels and campaigns, you can measure the long-term return on your marketing investments. Some channels may be more expensive in terms of acquisition costs but could bring in customers with a higher LTV, making the higher costs justified.
- Effective Budget Allocation: Knowing the LTV by channel allows you to allocate your marketing budget more effectively. Channels and campaigns with higher LTV can be allocated a larger share of the budget, while underperforming channels might require re-evaluation or optimization.
- Product Value Identification: Not all products have the same impact on customer retention and spending behavior. Some "gateway" products might attract loyal, high-spending customers, while others might attract one-time buyers. By understanding the LTV of customers based on their initial purchase, you can identify which products serve as better long-term value drivers.
- Toxic Bestsellers: Marketing channels such as Meta (Facebook, Instagram), TikTok or even GoogleAds tend to promote only one or a few products, because these products acquire customers for the lowest price, but completely disregard the LTV. As a result, you often have hidden champions in your shopify product portfolio that hardly get any attention. These supposed bestsellers are even often rather bad products, as they have low price points and thus attract customers for whom your other products are too expensive in comparison. In this way, you ruin your customer retention already in the customer acquisition phase.
- Inventory and Supply Chain Management: Products that lead to higher LTV might be given priority in inventory decisions, ensuring they are always in stock.
- Category Insights & Trends: Understanding LTV at a category level helps identify which categories serve as primary drivers of long-term customer value. This can reveal overarching trends about customer preferences, behaviors, and brand affinity.
- Bundling and Cross-Selling: If certain categories tend to produce higher LTV customers, products within these categories can be bundled or cross-sold with products from other categories, amplifying sales and customer value.
- Product Development & Expansion: High LTV categories can provide insights into where to expand or refine a brand's product range. New products developed within these categories might benefit from an existing loyal customer base.
- Merchandising and Store Layout: In physical or online stores, high-LTV generating categories can be placed in prime locations, such as the storefront or the homepage, to attract and convert more first-time buyers.
- LTV by Location: If you find that the LTV of your Shopify customers from certain cities is significantly higher than in others, you can also adjust your marketing budgets accordingly. Sometimes there are differences of 300%. We have analyzed why this is and found that there is a strong correlation between the purchasing power of certain cities and zip codes and the LTV of their customers. So it makes sense to adjust bids according to the LTV of the city. If you also have local stores, it also makes sense to analyze where many of your loyal customers already come from in order to determine the location of new stores accordingly.
- LTV by Gender: We found similar findings regarding gender distribution. Shopify itself does not provide information about the gender of your customers. However, RetentionX enriches this information and allows you to determine the LTV based on gender as well. Again, it makes sense to adjust the marketing strategy as well as the product portfolio accordingly as soon as you recognize significant differences between the behavior of men and women.
- Evaluate Promotional Campaigns: If you've issued multiple coupon codes through various marketing campaigns, understanding the LTV of the customers associated with each code helps determine which campaigns are attracting not just short-term buyers but long-term, high-value customers.
- Tailor Future Promotions: By knowing which coupon codes lead to high LTV, you can craft similar future promotions to attract similar high-value customers.
- Integrate with CRM and e-mail Marketing: RetentionX integrates with all major Customer Relationship Management (CRM), Customer Service systems and e-mail marketing tools (Klaviyo, Mailchimp,...). This allows for individual service levels and improved targeting.
- Create Powerful Audiences: With the help of RetentionX's powerful marketing automations, it's easy to transfer lookalike audiences of your best customers to your marketing channels after LTV. Create audiences in tiktok, meta ads, google ads or pinterest at the push of a button
Interpreting the Ratio:
The LTV:CAC ratio offers a clear insight into the health of a DTC ecommerce business's customer acquisition and retention strategy. Here's how to interpret different scenarios based on the ratio value:
LTV:CAC Benchmarks and Industry Variations
The ideal LTV:CAC ratio can vary across industries and business models. However, many successful DTC ecommerce brands strive for a ratio of at least 3:1, meaning that the customer's lifetime value is three times greater than the cost of acquiring them. This allows the brand ample room for reinvestment, innovation, and scalability.
It's important to note that LTV and CAC can differ significantly based on factors like the average order value, customer retention rate, and the competitive landscape within the industry. Regularly tracking and analyzing these metrics, along with the LTV:CAC ratio, can provide insights into the effectiveness of marketing campaigns, customer engagement strategies, and overall business health.
We have just briefly touched on how important LTV is for measuring marketing performance. It quickly becomes clear that it would be interesting to analyze the LTV of each individual marketing channel and campaign and to identify which marketing measure also brings the best customers. But this is only one of many interesting LTV dimensions for brands on Shopify.
LTV by Marketing Channel & Campaign
Evaluating campaigns based only on short-term metrics like click-through rates or initial conversion rates can be misleading. LTV provides a long-term perspective, ensuring that campaigns aren't prematurely judged as successful or unsuccessful based on initial results alone. LTV offers a holistic, long-term view.
By analyzing LTV across all marketing efforts, brands can make more informed decisions, maximize their marketing ROI, and build lasting relationships with high-value customers.
It’s always easier to retain a good customer than to try to reactivate a bad one.
LTV by Product
The product a customer chooses as their first purchase can be a significant indicator of their future behavior and value to the company.
By analyzing LTV through this lens, brands can make more strategic decisions across various facets, from marketing to inventory management.
LTV by Product Category
Analyzing the LTV by the specific category of products a customer purchases during their initial interaction offers a broader perspective than looking at individual products. Understanding this category-based LTV has various strategic implications:
LTV by Demographics
Analyzing the LTV by customer demographics, such as gender and location (both city and country), can offer valuable insights into the behavior and preferences of different segments of your customer base. Let's delve into the importance of such an analysis:
LTV by Discount Code
Analyzing the Lifetime Value (LTV) of customers based on the specific coupon codes they use provides actionable insights into the effectiveness of different promotional strategies. Here's why such an analysis is important:
Final Tips on using LTV on Shopify
LTV is a powerful metric for DTC brands on Shopify. It provides insights into customer behavior, guides resource allocation, and informs marketing strategies. By understanding and acting on LTV, DTC brands can drive growth and profitability.