Life Time Customer Value for Ecommerce Business

Jeremy Liew, of Lightspeed Venture Partners, does a great write up on ecommerce and estimation of lifetime value:

For an ecommerce business, rather than focusing on the percentage of retained subscribers per cohort, instead you focus on the net revenue (after discounts, returns and refunds) from that cohort in a given period. This revenue has to be normalized by dividing by the number of buyers in each cohort so that you can make meaningful comparisons. You should focus on revenue per buyer in each period for each cohort as the raw data from which you can build a lifetime value analysis. Then you should average across cohorts to understand “typical” revenue per sub in period 1, 2, 3 etc, where period 1 is the first month (quarter/ year) when you see a buyer make a purchase.

Sample cohort analysis for an ecommerce business

Lifetime Value is calculated as the cumulative contribution of an average customer, so you have to multiply lifetime revenue by contribution margin. Contribution margin should include all variable costs except one time acquisition costs. This typically includes COGS, packaging, shipping and handling, reverse logistics, inventory obsolescence/write offs, customer service, credit card charges, hosting costs, fraud accruals etc. It would not include fixed costs such as photography, production, site development, merchandising or other overhead.

The two most importnat metrics that I look at to gauge the health of an ecommerce business are LTV/Customer Acquisiton Cost ratio and payback period. This is why i highlighted these two metrics in the spreadsheet.

I like to see LTV/CAC > 2.5 (which tells you that you have a robust long term business with enough margin to cover overhead) and Payback periods under 12 months.

 

 

 

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