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The headlines continue getting worse and worse for the retail sector, as the rate of retail closures now more than doubles that of new store openings in the U.S. Despite these and other concerns, though, reports that we’re in the midst of a so-called “retailpocalypse” are a bit exaggerated.
According to the National Retail Federation, consumer spending during 2018 was up nearly 4.6 percent, and continued growth is expected for 2019.
It’s just that most of the increases will be via online channels.
The e-commerce market is strong, with global online sales projected to reach nearly $5 trillion annually by 2021. Of course, e-commerce has challenges of its own. Remote sellers have concerns that are unique to the online channel and don’t affect brick-and-mortar sellers.
Driving conversion, for instance, is much harder in an online setting. If a buyer is already in-store, there’s a better chance they’ll complete a purchase.
Verification is another challenge. Although online-only sellers don’t need to worry about maintaining physical retail locations, there are increasing costs. And this impacts how much e-commerce retailers should spend to win over buyers.
Explaining Customer Lifetime Value
I’ve observed the challenges facing e-commerce merchants, both as a service provider and merchant. Through those experiences, I found customer lifetime value to be a critical calculation.
Customer lifetime value, or LTV, is a figure representing the total value of profits you’d expect an individual customer to generate over their lifetime. LTV looks at the amount a customer spends, minus the amount of resources you invest in acquiring and retaining that individual.
If your LTV isn’t significantly higher than the costs of acquisition and retention, it’s not worth spending the money.
LTV should be considered when determining budgets for advertising, design, market research, operations, fulfillment and customer support. This simple calculation helps determine the best strategy to invest in promotions, loyalty programs and other methods of retaining buyers.
“This seems obvious,” you might say.
That’s true at first glance, but it’s shocking how often LTV goes overlooked, and entrepreneurs end up misallocating resources as a result.
E-commerce retailers that fail to monitor LTV have no reliable, objective guidelines for how much to spend on acquisition and retention.
Unfortunately, a 2018 study conducted in the U.K. found only one-third of marketers were even aware of what customer LTV is and why it’s important.
The result is that many retailers, especially those entrepreneurs who are new to the industry, mistakenly spend far too much to acquire customers.
How to calculate Customer Lifetime Value
To figure out your customer LTV, it’s important to know a few key figures.
- Average order value: Total annual revenue divided by transactions during the same period
- Annual purchases per customer: Total annual orders divided by unique customers
- Customer lifetime: Projected length of time a buyer will remain your loyal customer
With these three variables, simply multiply average order value by the number of annual purchases, then multiply the product of that by the total customer lifetime. While this isn’t an exact science, it offers valuable guidance as to how resources can be best allocated.
LTV should be a high-water mark; the amount spent to acquire and retain customers should be significantly lower than the buyer’s lifetime value. Otherwise, you won’t be in business very long.
There are numerous benefits to basing strategy on this figure.
With a solid picture of LTV, operational benefits include the ability to:
- Better monitor inventory, track merchandise and determine which goods to stock.
- Anticipate returns and refunds, and identify which purchases are more susceptible to returns.
- Create a more interactive customer experience and improve engagement.
- Be more responsive to changes in trends, technology and regulation.
Retention is better than acquisition
Of course, you want to attract as many new buyers as possible. That said, it costs significantly more to acquire a new customer than it does to retain an existing one.
Retaining and building up a loyal base of customers is one of the best strategies for growing a retail business.
Increasing customer retention by just 5 percent can increase profits by 25 percent to 95 percent.
Not only that, acquiring loyal customers means you’re building up a base of individuals who have faith in your operations.
Emphasizing customer retention isn’t as compelling a story as finding rapid success through viral marketing. But it’s a much more sustainable approach to ensuring long-term success and viability. Rather than shooting for the moon, you’re laying the foundation for ongoing success and growth.
No matter your approach, never lose sight of the importance of calculating your customer lifetime value. Monitor this figure closely and adjust your strategies as necessary. It’s never going to be perfect, but that just means there’s always room for improvement.