One commonly used metric retailers use when acquiring customers is revenue per user. This number is useless for any business that has repeat customers. Here’s why:
If you are trying to evaluate your customer base and want to figure out the value of a customer, a naive approach is to look at total revenue your business has made, and divide that by the number of customers.
Suppose one business sees that the average customer has spent $64. However this is not the lifetime value of customers, it is just the average observed value. We know that we can spend at least this much to acquire a new customer. However this is less than the lifetime value of a customer. This is especially true if our business is rapidly growing, and we have been acquiring many new customers. In this case, our customer database is full of young customers who are far away from realizing their full potential.
Instead it is important to look at the lifetime value of customers, so instead of dividing by the total number of customers, you can divide by the total number of years that a customers have been active. Then we get a number such as customers spend on average $53/year. Thus if we are interested in the two year value of customers, we realize that we can actually spend up to $106 per customer.
However, for many business (especially young ones) this is actually an overestimate of the customer value, since customers are most engaged after their first purchase then slow down their purchasing over time, or take their business elsewhere. In order to accurately predict customer lifetime value, you need to either only look at customers who have been alive for the period in question, or to use a customer lifetime value model to make the predictions. In the case of our example, the actual two-year value of a customer turned out to be $81, somewhere in between the two estimates.