What is Lifetime Value of customer

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Have you ever heard about LTV? well if you talk about Macroprudential policy, it will be loan to value. But if you talk about startups and the world of tech, it refers to the Lifetime value of a company. 

So 

Lifetime Value (LTV) is a metric that represents the total revenue a business can expect to earn from a customer throughout their entire relationship. It is a crucial metric for assessing the long-term profitability of acquiring and retaining customers. The calculation usually involves factors such as the average purchase value, the frequency of purchases, and the customer retention rate.

The formula for calculating a customer's Lifetime Value (LTV) can vary depending on the specific business model and the metrics used. However, a common formula to calculate LTV is as follows:

\[ LTV = \text{Average Purchase Value} \times \text{Number of Purchases per Year} \times \text{Average Customer Lifespan} \]

Here's a breakdown of the components:

1. **Average Purchase Value**: This is the average amount of money a customer spends on each transaction.

2. **Number of Purchases per Year**: This represents the average frequency a customer purchases from your business within a year.

3. **Average Customer Lifespan**: This is the average time a customer continues purchasing from your business. It can be calculated by taking the reciprocal rate of the churn (the rate at which customers stop doing business with you).

Once you have these three values, you can multiply them to find a customer's Lifetime Value. It's important to note that LTV is a dynamic metric that can be adjusted based on changes in customer behavior, retention strategies, and market conditions.

Let's break down the formula with an example:

\[ LTV = \frac{(Average Purchase Value \times Purchase Frequency \times Average Customer Lifespan)}{Customer Churn Rate} \]

Assume we have an e-commerce business:

- Average Purchase Value: $50
- Purchase Frequency: 2 transactions per month
- Average Customer Lifespan: 24 months
- Customer Churn Rate: 0.2 (or 20%)

Now plug these values into the formula:

\[ LTV = \frac{(50 \times 2 \times 24)}{0.2} \]

\[ LTV = \frac{2400}{0.2} \]

\[ LTV = 12,000 \]

So, in this example, the Lifetime Value (LTV) for each customer is $12,000. This means that, on average, the business can expect to generate $12,000 in revenue from each customer over its entire relationship with the company, taking into account the average purchase value, purchase frequency, customer lifespan, and churn rate.

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