How PMs can measure the success of their Product — Understanding Customer Lifetime Value
Customer lifetime value is the total worth to a business of a customer throughout their relationship with your product. It’s a worthier metric in comparison to revenue or ROI, for assessing the financial performance of your product.
Benefits of Customer lifetime value :
- It encapsulates the customer’s overall gross margin contribution from day 1 till they churn out.
- It helps to streamline resources towards retaining old customers instead of running after the new ones.
The formula for calculating customer lifetime value 👇
- ARPC ( Avg revenue per customer )
It is defined as the average monthly revenue earned from each customer. It comprises revenue earned from all kinds of streams such as direct sales, subscription, advertisement, cross-sells, and upsell of product to existing customers.
- COGS ( Cost of goods sold ) — COGS include all the variable costs associated with delivering products to customers, such as customer support, retention initiatives, product refunds/ returns.
- GM ( Gross margin ) — Subtracting COGS from ARPC will give gross margin per customer.
- Churn rate — It’s the %age of customers who dropped off from your product each month. On average, this %age trends at 3 to 5% every month for the majority of the products.
- Customer lifetime value (LTV) — It’s an aggregation of the monthly gross margin divided by the churn rate. It depicts the value generated by an average customer over the entire duration of their engagement with the product.
Customer acquisition cost ( CAC )
To holistically calculate the business value, it’s important to compare the LTV value against the CAC. It’s an initial cost of acquiring the customer.
In practice, LTV is measured against each of the channels ( organic, paid, referrals, etc ) and corresponding CAC is compared. To turn profitable LTV should be greater than CAC.
For instance, paid channels will have higher CAC but lower LTV whereas organic channels might have higher LTV and lower CAC ( It’s zero !). This implies that it’s beneficial to scale the product through organic channels.
However, in case the objective of your product is to acquire more users and focus entirely on growth then these are not the relevant metrics to look at.
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