Did you know Amazon loses money in every Kindle purchase?

Well, it’s not surprising if you didn’t. Because even if we know something is wrong, it’s alright as long as it's profitable and the stocks are rising.

With current startups, it's pretty normal to make losses with its product or services; in fact, people are surprised when one of them is profitable. But for a company like Amazon, how does it make any business sense? The answer: The Customer Lifetime Value or LTV/CLTV. (For this article, we will refer to this metric as LTV)

Customer lifetime value (LTV) indicates the total revenue a business can reasonably expect from a single customer throughout the business relationship. In other words, it is the average amount of money they spend with you before they churn.

Calculating LTV

Let's say the average sales in a clothing store is ₹80, and, on average, a customer shops four times every two years. So the LTV is calculated asLTV = ₹80 x 4 x 2 = ₹640.

You can further refine this metric by adding the profit margin to the equation. Let us assume that after removing the operating expenses and cost of goods sold, the profit margin is 20 %. (Adjusted) LTV = LTV x Profit Margin =20 % of ₹640 = ₹128

🧐  Why LTV is important?

LTV is an important metric because it shows you a more complete picture than other figures. For example, ARPU (average revenue per user) shows what you are charging, on average, for a customer in a given month.

What it doesn’t show is whether or not your customers are going to keep paying that amount for a long or short period or if they are likely to upgrade and pay your company more in the future. Coming back to the Amazon Kindle, even though Amazon makes a loss in selling Kindle, it more than makes it up from the continued purchase of books from Amazon.

Calculating the LTV gives you a clarity on how much you can actually spend on acquiring a customer.

😕 LTV Ke Side Effects

An interesting side-effect of LTV is how some industries can come together to purposefully restrict the life of a product to increase the LTV.

Let’s take the case of iPhones. Buying Apple products is like taking afternoon naps or morning tea. Once you start with it, there is no going back. It’s like you’re Dormammu, apple is Doctor strange, and you’re stuck in a loop forever.

Recent surveys have pointed out that people change their iPhones on average between 3 - 4 years. Apple itself says the life cycle of a typical iPhone is now three years.

Tips to keep in mind while looking at LTV metric

1. Always segment your customers while calculating LTV: The Customer Lifetime Value or LTV/CLTV. (For this article, we will refer to this metric as LTV)

2. Focusing on only revenue when calculating LTV instead of profit can give a wrong picture: In the above example, if they looked at LTV as only 640, the business could be misled into burning more money to acquire users while the adjusted profit is only ₹128.

3. Recalculate LTV regularly: If the business is constantly in flux, then you must keep calculating the LTV regularly to keep it in check.

4. Be wary of discounting: If the idea is to improve the LTV over time, they can erode the margins and could damage the LTV.

Did you know? 

Change your referral messaging with pre-designed message to increase referrals. The message that the sender bought it (e.g. “Your friend bought this, check it out”) can boost conversion rates by 11%.

OR

A referral incentive (e.g. “Buy this, then invite friends and you’ll get it for free”), can increase referrals by 53%. 

Don't use both at the same time. 

Source: Sun, T., Viswanathan, S., & Zheleva, E. (August 2020). Creating social contagion through firm-mediated message design: Evidence from a randomized field experiment. Management Science.