How to Calculate Customer Lifetime Value

How to calculate customer lifetime value, step by step

Customer lifetime value is one multiplication that answers one question: what is one customer worth to your business over the whole time they buy from you? A business that knows the answer can decide what to spend winning a customer and what to spend keeping one. The calculation is the average order value times the purchases per year times the lifespan in years — three numbers you can find in any sales record, multiplied together. The answer is a dollar figure per customer: a value of $3,000.00 means the average customer hands the business three thousand dollars before they stop buying.

The formula is customer lifetime value = average order value × purchases per year × lifespan. Average order value is what a customer spends in one order, on average — total revenue divided by total orders, over the period you are measuring. Purchases per year is how many times the customer buys in a year — total orders divided by total customers, per year. Lifespan is how many years the customer keeps buying — how long, on average, a customer stays with the business before they stop. All three figures come from the same sales records, in the same currency, or the value is wrong before it starts.

The worked example, line by line. Step 1 — the average order: $50. Step 2 — the purchases per year: 12. Step 3 — the lifespan: 5 years. Step 4 — the yearly spend: $50 × 12 = $600.00 a year. Step 5 — the lifetime value: $600.00 × 5 = $3,000.00. Step 6 — the meaning: $3,000.00 means each customer is worth three thousand dollars over five years. Work it yourself in the customer lifetime value calculator.

What the number means

A value of $3,000.00 means each customer is worth three thousand dollars over five years. That is the revenue one customer brings in, from the first order to the last, before any costs are taken out. A higher value means the customer is worth more to the business, so the business can afford to spend more winning them and more keeping them. A lower value means the opposite: the customer brings in less over the whole relationship, so the business must spend less to win them or find a way to make them worth more.

What moves the value

Order value moves it fastest in one direction: every extra dollar on the average order adds sixty dollars to the value, because the customer buys twelve times a year for five years — twelve times five is sixty. Purchases move it the other way round: every extra purchase a year is worth a whole order times the lifespan, so a customer who buys more often is worth more even when the order stays the same. Lifespan moves it slowest but furthest: every extra year is worth a whole year of spending, so a customer who stays twice as long is worth twice as much.

How much order value do you need for a $3,600.00 value?

The reverses tell you where the line sits. The smallest order value for the value to reach $3,600.00 is $60 on 12 purchases a year and a 5-year lifespan — at a $60 order the value is exactly $3,600.00. The smallest purchases a year for the value to reach $3,600.00 is 15 a year on a $50 order and a 5-year lifespan — at 15 purchases a year the value is past $3,600.00, and one fewer purchase a year is not enough to reach it. One dollar on the order, or one purchase a year, moves the value across the line, and the displayed figure hides nothing — which is the trap the next section covers.

Traps to avoid

First, the zero cases. If the average order is $0, the value is $0.00 — a customer who never pays is worth nothing, however long they stay. If the lifespan is 0 years, the value is $0.00 too — no years, no value. The calculator shows both figures with notes, never hides them. A customer who buys nothing is worth nothing, and a customer who stays no time is worth nothing, and both cases are real.

Second, the no-division rule. There is no division in this calculator, so there is no undefined case — no input can make the value undefined. The value is a product of three numbers, so it always has an answer, even when the answer is $0.00. Do not invent an undefined case where none exists, and do not divide anything by the value to get a second answer the formula never promised.

Third, revenue is not profit. The value is revenue per customer, not profit — it says nothing about what each order costs to fulfil, what it costs to win the customer, or whether the customer pays on time. Work out the margin in the gross profit margin calculator and how much of the profit the business keeps in the retention ratio calculator. A customer worth $3,000.00 in revenue can still lose the business money if the margin is thin and the acquisition cost is high.

Frequently asked questions