If you are active in the e-commerce sector or operate an online shop, then you will certainly have either already heard of the terms LTV and ROAS or even have to deal with them on a daily basis. But what is lifetime value and how does it influence return on ad spend? And most importantly, how can you turn LTV-based ROAS to your advantage, giving you a huge lead over the competition? Raphael Rohner, CEO of R17 Ventures AG, explains all this.
What is the Customer Lifetime Value LTV?
The LTV is the value of a customer measured in revenue over a certain time unit XY. Since the e-commerce business - especially in the paid media sector - is very fast-moving, one usually takes 1 year as the unit of measurement. This way, the chances of miscalculating are lower than if you extrapolate it to 4 or 5 years. What does the value of a customer say within one year? If you take the AOV - Average Order Value (i.e. the average shopping basket) and multiply it by the frequency with which customers typically shop, you get the turnover value of a customer per year. The shopping frequency can be e.g. 1 x per month or 3 x per year, it all depends on your product. You can take the values either from statistics or from your own experience. Of course, it gets really exciting when you not only know the turnover value, but also the gross profit per customer. To do this, you subtract all variable costs from the turnover value that can be directly assigned to the order or the products. These are for example
- Costs of Goods Sold (product costs)
- Logistics / Shipping
- VAT etc.
This is how you get the lifetime profit of a customer.
ROAS - Return on Advertising Spend
This important e-commerce metric measures the effectiveness of an ad within a short period of time. What is the revenue figure you get when you invest 1 CHF/dollar/euro in paid media? Typically, the attribution window in which revenues can be attributed to an ad is between 7 and 28 days. The ROAS therefore measures the profitability of the advertisement within this time window.
What are the advantages of an LTV-based ROAS?
If you combine the two KPIs LTV and ROAS, you get the advantages of both measures. On the one hand, there is the long-term nature of the lifetime value. This means that you take into account: How often and for what amounts does a customer make a purchase in a year? At the same time, there is the short-term profitability of the advertisements: How high is the turnover for an investment of 1 euro/dollar/CHF in advertising?
Advantage No. 1: A much more long-term view of paid media
If you purchase a customer relatively expensively via paid media (e.g. Instagram), this can seem quite un-lucrative at first. However, if this customer comes back in two months and makes another purchase after being re-targeted via a Google Search or Google Smart Shopping Ad, you can persuade this customer to buy again via a significantly lower CPA (Cost per Acquisition). All these factors are taken into account in performance marketing with the lifetime value-based ROAS and you start to think more long-term.
Advantage No. 2: Use of AI-driven campaigns in performance marketing
Google's Smart Shopping campaigns use machine learning to create a variety of ads on different networks from your product feed. Accordingly, these are displayed on the Google search network, the Google display network as well as on YouTube. Different combinations of the image and text elements you provide are tested and the most relevant ads are automatically selected. Let's imagine we have two online shops that both sell Pampers. Both have the same product, both have the same manufacturing costs or purchasing conditions with P&G and both run Smart Shopping campaigns with Target ROAS. Let's assume that online shop A works with us at R17 and receives a good analysis of its LTV-based ROAS. They know that the typical customer doesn't just shop once, but 6 times and how much they shop. Shop B, on the other hand, focuses only on the traditional ROAS-based approach, i.e. how profitable is the one and first purchase? Shop A, with its LTV-based approach, naturally has a big advantage: it can lower its ad bid because it knows it will earn money on the second, third and fourth purchase. As a result, he will win every auction against shop B because he has a lower target ROAS bid. This in turn results in further advantages: He receives a significantly higher sales volume as well as many more customers and the competitor is slowly but surely forced out of the market because he cannot keep up with Shop A's Target ROAS.
CONCLUSION: The LTV-based ROAS is an ideal mix of the two KPI's
LTV is important for the long-term view, whereas ROAS is important for the short-term effectiveness and profitability of your advertising. A lifetime value based ROAS therefore has the following advantages:
- You focus on a more long-term view and understand the business better.
- You have a big head start in AI-driven campaigns such as Google Smart Shopping
Was this topic of interest to you? Then we have a little extra for you. You can download a free LTV-based ROAS calculation as a Google Sheet and calculate your individual LTV-ROAS: Download LTV-ROAS Calculation