How to Calculate Unit Economics & LTV for eCommerce Subscriptions

Most eCommerce brands miss enormous opportunities to optimize cash flow and profits by misunderstanding their unit economics. The thing about unit economics is that they are not very intuitive - often they reveal that ideas that seem "good" really are quite unprofitable, or ideas that seem "bad" are actually very profitable. 

In this blog post, we'll break down how to calculate unit economics and LTV for eCommerce subscriptions. We'll dive into a short case study, walking through each step.

By the end, you'll be equipped to optimize your subscription model, boosting both revenue and customer retention.

Table of Contents

1. What Are Unit Economics?
2. Calculating Per Order Unit Economics
3. Customer Lifetime Value (LTV)
   
   1. Methods to Calculate Customer Lifetime Orders
      1. Using Churn Rate
      2. Customer Cohorts
   2. Customer Lifetime Value Calculation
4. Conclusion

What Are Unit Economics?

Unit economics measure your financial performance on a per-customer basis. This framework includes the customer lifetime value (LTV), which represents the total gross profit a business makes from its relationship with a single customer over time.

By improving the economics of each customer relationship, you optimize your entire business.

There are two steps, the first is calculating your economics on a per-order basis, and then the second is calculating them on a customer lifetime basis. Let's start with step 1.

Calculating Per Order Unit Economics

To start, differentiate your subscription business from other revenue streams. Focus on the subscription component and identify all the costs associated with it. This helps in calculating accurate per-order and customer lifetime metrics.

Example Data:

• Monthly Orders: 3,265
• Monthly Revenue: $735,684
• Monthly Product COGS: $201,142
• Monthly Fulfillment COGS: $100,197

So on a "unit economics" aka per-order basis, you have:

• Average Order Value (AOV): $225
  
• Product COGS per Order: $62
  
• Fulfillment COGS per Order: $31
• Gross Profit per Order: $225 - $62 - $31 = $133

 These are your per-order unit economics. Now let's talk about the customer lifetime metrics. 

Customer Lifetime Value (LTV)

LTV is calculated by multiplying the per-order economics by the average number of orders a customer places in their lifetime.

Methods to Calculate Customer Lifetime Orders

Churn Rate Method

Churn rate is the percentage of customers canceling their subscriptions each month. You can calculate lifetime orders using the formula:

Lifetime Orders = 1 / monthly churn rate 

Example: 

• Churn Rate: 32.2%
• Lifetime Orders = 1 / 32.2% = 3.1  

Customer Cohort Method

The other and more precise way to calculate lifetime orders is to use customer cohorts. Cohorts help you track how many customers continue to place orders over time. 

Here's an example. The following cohort shows the average retention of your customer base by lifetime order. 

• Order 1: 100%
• Order 2: 60%
• Order 3: 50%
• Order 4: 30%
• Order 5: 25%
• Order 6: 15%
• Order 7: 12%
• Order 8: 8%
• Order 9: 5%
• Order 10: 3%
• Order 11: 2%
• Order 12: 1%

Now if you add all these retention numbers up, you will get the average number of purchases that a customer makes over their lifetime. In this case, it will be the same number that we saw above, 3.1 lifetime orders. Cohorts are just a different way to display the same dynamics. 

Customer Lifetime Value Calculation

Now that we have both the per-order economics, and the lifetime orders, we just need to multiply them together to understand the customer lifetime economics. 

We have two main metrics we track on a customer lifetime basis:

1. Customer Lifetime Revenue (often confused for customer lifetime value): the total revenue a customer generates over their lifetime. 
   • Calculation:  Total Lifetime Orders * AOV = 3.1 * 225 = $698
2. Customer Lifetime Value: the total lifetime gross profit a customer generates over their lifetime.
   • Calculation: Total Lifetime Orders * Gross Profit per Order = 3.1 * 133 = $412

Conclusion

Now that you know that you will make, on average, $412 in profit on your lifetime relationship with each customer, you can more accurately plan your customer acquisition costs and marketing investments, as well as optimize pricing and retention strategies to lift lifetime values. 

If your brand is looking to drive increased customer lifetime value through eCommerce subscriptions and needs advanced capabilities like prepaid subscriptions, memberships, and bundles, or if you're on a homegrown system and want to lower your technology costs and innovate faster, book a demo with Ordergroove to learn how you can take your customer lifetime value to the next level.