How to calculate Customer Lifetime Value and Customer Acquisition cost on Amazon

Introduction

In today’s dynamic e-commerce landscape, understanding customer behavior and their value to your business is paramount. Amazon, the e-commerce giant, is renowned not only for its vast marketplace but also for its mastery in leveraging customer data to drive growth. One crucial metric is Customer Lifetime Value (CLTV). In this guide, we investigate the significance of CLTV for Amazon sellers, explore how it’s calculated and uncover strategies to optimize and maximize this metric for sustainable business success. 

What is Customer Lifetime Value (CLTV)? 

CLTV or Customer Lifetime Value estimates the total value a customer generates for a business during their buying journey. For ex. If a product average order value is 5$, and the customer buys it 3 times in 1 year, then the CLTV of that customer is 15$. As selling on Amazon gets more and more expensive over time, it is important sellers focus on increasing CLTV. A high CLTV justifies high marketing costs by the company (discussed later in this post).  Why do sellers need to know CLTV:  

1. Strategic Decision Making:

The 80-20 rule applies to all businesses. 80% of the sales comes from 20% of customer segments. Knowing CLTV tells sellers which customers are most valuable to their business. With this knowledge, Amazon sellers can tailor their marketing efforts and allocate resources more efficiently. 

2. Retention Focus:

Acquiring new customers is undoubtedly crucial, but retaining existing ones can be even more lucrative. CLTV helps in identifying high-value customers, allowing sellers to prioritize retention strategies and foster long-term relationships. 

3. Personalization Opportunities:

By understanding the preferences and purchasing patterns of high CLTV customers, sellers can customize product detail pages and marketing language to attract similar ones. This will help them speak to their potential buyers, thereby enhancing customer satisfaction and loyalty. 

What impacts Customer Lifetime Value: 

Customer Lifetime value depends on following parameters:  

1. Retention Rate: The percentage of customers who continue to engage with Amazon over time. 

2. Purchase Frequency: What is the number of times a customer buys your product on Amazon 

3. Average Order Value (AOV): The average amount spent by a customer in each transaction 

4. Customer Acquisition Cost (CAC): The cost incurred in acquiring new customers. 

How to calculate Customer Lifetime Value:  

Amazon employs sophisticated methodologies to compute CLTV accurately, leveraging data analytics and machine learning algorithms. One such approach is the RFM (Recency, Frequency, Monetary) analysis, which segments customers based on their transactional behavior. We have listed the segregation (based on behaviors) for you below: 

Recency: How recently did that customer make a purchase? 

Frequency: How often does a customer make purchases? 

Monetary: The total monetary value of a customer's purchases.  

Calculation:

You can calculate customer lifetime value using the Amazon Fulfilled Shipments report Calculation:

Select the same time period to download all these reports.  

1. Calculate Average Purchase Frequency: Divide the total number of purchases by the number of unique customers during the same period, and you get your average purchase frequency rate of that product  

   
   

2. Average Purchase Frequency =  Unique Orders/ Unique customers over time period (ex. 1 year) 

   
   

3. Calculate Average Order Value (AOV): The total revenue generated from all purchases divided by the number of purchases made over a specific period, gives you the average purchase value which will help you understand the customer’s average spending ability  

   
   

4. Average order value = Total Revenue/ Total Orders over time period (1 year as per above) 

   
   

5. Calculate average customer value = Multiply the average purchase value by the average purchase frequency rate to obtain the average customer value.

   
   

   This will tell you how valuable each customer is based on the revenue they bring to your brand/product.

   
   

   Using this, you can come up with effective marketing strategies and know what the customers’ purchasing habits are, helping you curate more personalized experiences. 

   
   

   Average customer value = Purchase frequency * AOV 

   
   

6. CLV = Now you must multiply the average customer value by the customer lifespan to arrive at the CLTV.

   
   

   Once you have figured out the CLTV, the next step is to understand how this can be used in your brand’s favor to drive sales optimally.  

   
   

   CLTV = Average customer value * 1 year  

Too many steps? How about a quick calculator to calculate this. Jon Derkits built an easy calculator to calculate CLTV in 3 simple steps. You can access the calculator here.

Strategies to Optimize CLTV on Amazon 

Customer Lifetime Value (CLTV) will give you plenty of insights into how your product is performing on the retail platform, it is important to use this data to analyze and eventually optimize customer experience to ensure that your CLTV is always high. Here are some ways you can do that: 

Enhance Customer Experience: The best way to retain a customer is by providing a good quality product and exceptional customer service. This will ensure that the customer keeps coming back to buy your product multiple times.  

Subscribe and Save: If your product is eligible for subscribe and save, then that is a great way to lock in a customer for longer duration. Rewarding loyal customers with incentives such as discounts, exclusive offers and rewards points can incentivize repeat purchases and increase CLTV. 

Cross-Selling and Upselling: Analyzing customer purchase history to identify opportunities for cross-selling related products or upselling higher-value items, will help maximize the CLTV. Experiment with different strategies that will work for your product and identify the one that works best. An easy way to do it through Amazon advertising is to advertise bundles and high AOV items on branded search terms. Customers who find you through branded search terms are already a loyal customer base, and hence can be shown higher AOV, or bundled products to increase CLTV. 

Segmentation and Targeting: Segmenting customers based on their purchasing behavior, demographics and preferences allows for targeted marketing campaigns tailored to specific customer segments, driving higher CLTV. In simple terms, the more you market to the customers that need/want your product, the more likely it is that your product will sell. 

Continuous Analysis and Optimization: Regularly monitor CLTV metrics and adjust strategies accordingly. Experiment with different marketing tactics, product offerings and pricing strategies to continuously optimize CLTV. This becomes vital to ensure that you stay in the race and win amongst your competitors. Outdated tactics might set you back in big ways and have you lose your advantage over your competitors.  

Challenges and Consideration: 

While Amazon excels in harnessing CLTV insights, several challenges persist. Despite cracking great strategies through the several optimization options available across platforms, a few concerns listed below should be carefully tread over: 

Data Privacy: As Amazon collects vast amounts of customer data, ensuring data privacy and security remains paramount and sometimes can be a challenge.  

Dynamic Marketplace Dynamics: Amazon operates in a dynamic marketplace with evolving consumer preferences and competitive landscapes, necessitating continuous adaptation and innovation. 

Measurement Accuracy: Despite sophisticated methodologies, accurately measuring CLTV remains a complex endeavor, influenced by various factors such as seasonality, external economic factors and customer sentiment. 

Now that you know all about customer lifetime value, how do you know what value is good and what is bad. CLTV is seldom measured in isolation. Usually, CLTV is measured along with another metric, Customer Acquisition Cost.

What is Customer Acquisition Cost (CAC) all about? And how is it related to Amazon Customer Lifetime Value?

Let’s take a look! CAC represents the cost a brand incurs to acquire a new customer. It measures the efficiency and effectiveness of a brand’s marketing and sales efforts in attracting new customers. CAC focuses on the upfront expenses associated with acquiring customers, such as advertising, marketing campaigns, sales team salaries and promotional activities. 

Now, the relationship between CAC and CLTV lies in their comparison: 

CAC versus CLTV Comparison: 

Ideally, a company wants the CLTV to be significantly higher than the CAC. If the CLTV exceeds the CAC, it means that the company is generating more revenue from each customer than it costs to acquire them. This scenario indicates that the company's customer acquisition efforts are profitable and sustainable in the long term. It implies that the business is not only recovering the costs associated with acquiring customers but also generating a positive return on investment (ROI). 

In the context of Amazon, where the company operates on a massive scale across various product categories and services, optimizing both CAC and CLTV is crucial for maintaining profitability and driving sustainable growth. 

While CAC focuses on the cost of acquiring customers, CLTV looks at the long-term value those customers bring to the business. By comparing CAC to CLTV, companies like Amazon can assess the effectiveness of their customer acquisition strategies and ensure that they are acquiring customers at a sustainable cost relative to the value those customers generate over their lifetime. 

By understanding the lifetime value of each customer and implementing strategies to optimize CLTV, Amazon sellers can drive sustainable growth, foster customer loyalty and stay ahead in the competitive e-commerce landscape. Remember, in the world of Amazon, focusing on building long-term relationships with customers is key to unlocking the full potential of your business. 

Did you find this post useful. To know more about CLTV and CAC, feel free to book a meeting with us here.