Do you know the true value of your customers?
Customer numbers, revenues and retentions are in many ways the rocket fuels of business success. Certainly if you wish to impress bankers, investors and the market in general with corporate growth under your leadership and management you had better understand and pay homage to this important trilogy.
Do you know the true value of your customers?
What is the key metric you use to measure and drive your business?
When asking this question I find that most answer with “EBIT”, “margins”, “revenues”, ROI or some other fairly common KPI, however, I believe “Customer Lifetime Value” (LTCV) is perhaps the most significant measure to indicate the general health, sustainability and true value of a business. It is one of the most overlooked and least understood KPI’s or metrics in business, and yet it is one of the easiest to quantify.
Why is this particular metric so important? Because truly understanding it will deliver rewards, it will give you an accurate indication of how much repeat business you can expect from a particular customer, which in turn enables you to accurately forecast, cost and develop your business.
The value of LTCV in determining marketing spend and direction is immeasurable as it will not only help you to decide how much you can afford to spend to “buy” each new customer for your business, it will also motivate you to grow your business by showing you when and when to spend.
Once you understand how frequently a customer buys, how much they spend and for how long you retain them you will better understand how to allocate your resources to optimize customer growth and retention programs.
An easy calculation to estimate CLTV is to insert actual or estimated (if you’re in the planning stages or just starting out) numbers into the following equation:
(Average Value of a Sale) X (Number of Repeat Transactions) X (Average Retention Time in Months or Years for a Typical Customer)
A simple example would be the calculation of a service subscriber who spends $20 every month on a 3 year average retention. The CLTV would be:
$20 X 12 months X 3 years = $720 LTCV
We can see from this hypothetical example why so many successful businesses offer a free or discounted service to attract new customers and grow their business. Savvy entrepreneurs know that as long as they spend less than (say) one year’s revenue of $240 to acquire a new customer, the customer will quickly prove profitable and add a further CLTV to the business.
Further refinements can be made by calculating the margin value of each customer and the cost/benefit of a stronger customer service and or retention program.
Once you can demonstrate the multiples of CLTV you place your business in a very strong position should you later require additional funds for expansion from banks and financiers or equity from investors
Growing your CLTV
Once you have some idea of the lifetime value of your customer, you have two Targeted Marketing options in deciding how much to spend to acquiring each new customer:
Allowable acquisition cost: This is the maximum amount you’re willing to spend per customer per Targeted Marketing campaign – In this instance ensure the cost expended is less than the profit made on the first sale. This is an excellent short-term strategy for an emerging business or one in which cash flow is a concern.
Calculated Investment acquisition cost: This is the calculated cost you expend per customer in Targeted Marketing where you know that you will take a loss on initial and occasionally subsequent sales as you have pre-determined that you have the available cash resources to fund your marketing investment. This is a longer-term strategy ideal for mid-life to mature businesses looking to consolidate growth patterns and market share.
Marketing: Expense or Investment?
This is an interesting question which all entrepreneurs should resolve very early in their careers. In my assessment marketing must always be an investment with a measurable ROI. Understanding the LTCV of your customers provides you with such an ROI, a metric easy to establish and measure.
You will struggle to develop an optimal marketing budget unless you know what the return on your investment needs to be. This knowledge is essential as it will lead you to make sound marketing decisions based on the reality of sound and supported metrics rather than the ethereal promises of a new media promotion or program.
Understanding your LTCV’s provides you with specific knowledge as to how, or if, you can discount or offer incentives to attract new business. It will help you avoid the potentially disastrous effects of discounting when your business needs cash flow to survive. In addition, you will find innovative ways to build value upfront and create offers that drive enough volume to support and eventually increase your overall LTCV.
Think this through and take some time to calculate the LTCV equation as it applies to your business no matter if you are established, growing or just starting out. This is the metric for everyone.
In summary, the LTCV will determine the planning and frequency of your marketing spend, the ultimate success and thus the ultimate value of your business.
The Barking Mad Blog
Business Advice with Bite
“How important is profit?” this question in one form or another is one of the most common questions we receive from start-up owners or potential start-ups and surprisingly it’s not a simple answer.
Some time ago I sat down for a chat with a highly intelligent friend who had recently joined the board of a mid-sized family company. “I just don’t get it” she said “everyone tells me the business is booming, sales are up, profits are up yet from what I read the company is broke”.
My friend had sat down with the half year results and looked at the first two quarters performance against budget. Revenues were up by around 35%, Gross Margin was tracking, as a percentage, around 5% better than budget and operating expenses were around 11% lower than budget leaving a very healthy EBIT compared to budget and management applauding themselves all round.
Where is the problem? I hear you ask.
Cash or rather the lack of it was the problem. As revenues and revenue projections grew the funds allocated to the raw materials and finished goods needed to service such growth had increased exponentially as had the debtor’s ledger.
Yes the business was producing more at lower cost and selling every item produced at a profit but amongst the excitement no one had calculated the impact on future cash flows.
If you achieve an EBIT of 20% (which is on the generous side) it means you have to outlay costs, in advance, of at least $0.80c in every dollar of anticipated revenue. You may offset this to some extent by negotiating an extension to trading terms with your creditors but that is a very slippery slope and best avoided.
If you sell your product to a major retail chain, they will look to pay you in 60 days from the end of the month in which you invoice them. So you could easily wait 60 to 90 days for payment. For every $10 of widgets you sell them each month your cost is $8 and if you carry that and the subsequent monthly sales until you are paid, you are out of pocket by $24 before you receive a cent. On top of which you have had to lift your finished goods to 60 days stock to meet varying demand and raw materials by 45 days so you are roughly $50 out of pocket as you wait for the $10 to be paid of which you retain $2 profit or EBIT.
Yes you are still profitable but your short term cash burn is exceeding income and without a rethink your fast growing, profitable enterprise is going to crash.
“A profitable business without a cash flow is dead in all but name!”
My friend could see where the company was heading whilst the sales manager was elated by high revenues, the production manager proud of the COGS and the operations manager satisfied by the low level of OPEX. In all businesses good cash flow management and budgeting is essential.
There were several funding options available to secure this company’s future once the threat was identified. But within 60 days the company may have been in turmoil and no funder wants to lend into a panic.
So in answer to the question; profit is very important but it is just one of what I call “The Four Pillars of Business”: Revenue, Cost, Profit and Cash; and always remember that whilst the first three are very important CASH IS ALWAYS KING.
The Barking Mad Blog
Business Advice with Bite
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Great Teams Win!
And Keep on Winning
We Aussies know all about teams.
We have the AFL the NRL, the Premier League, not to mention cricket, hockey, swimming, tennis, netball, bowls and of course the local drinking team.
Every one of us passionately follows a team or two so of course we know all about team work…..don’t we?
In management speak we come across the words team, teamwork, team building, team targets every day without giving a very much thought as to what a team really is and how it functions.
The most simplistic and common dictionary definition of a team is: “to come together to achieve a common goal”. Essentially the objective of teamwork is to achieve more than the sum total of the individual people involved.
Pretty simple hey? And yet recently I came across two comments which demonstrated to me that not everyone finds the team concept so simple.
The first comment was in the form of a question to a SME advice column in a major daily newspaper – “I recently started a small business with a partner and he doesn’t work as hard as me. How can I get him to lift his input?”
The second was a question asked during a seminar “As a team leader I find it very difficult getting everyone in a team to contribute equally; what do you recommend?”
In both instances my thought was that these guys just don’t understand team work!
Let’s return to the definition and to that “common goal”. The first thing a good team leader does is to define the “common goal” the individual tasks out and best match the team members to the task. A simple team check list can help such as:-
Very clearly and simply define the Common Goal
Determine the best strategies to achieve the Common Goal
Identify the individual tasks to achieve the Common Goal
Clearly communicate the Common Goal and the individual tasks to the team
Discuss the strategies and tasks with the team and allow for questions and input
Analyse the individual team members, their skills and their responses to the Common Goal
Allocate the individual tasks to team members. Ensure each member understand what the whole team is doing
Lead but allow autonomy within tasks
Remember you may be the leader but your objective is for THE TEAM to be successful
Build RESPECT & TRUST with each member for the different skills and contributions they bring to the team
Sporting teams are very good examples of team work; as the batsmen toil in the sun chalking up a hundred runs do they resent the rest of the team sitting back in the pavilion? In a soccer game the goal keeper spends most of his time standing around whereas the forwards are running several kilometres, constantly tackling opposing players to gain control of the ball.
These sporting teams understand the essence of team work; it takes different members with different skills to tackle different tasks at differing times to deliver the very best result.
In my experience the more diverse the skills and personalities the more effective the team, be it a corporate management team, taskforce or board. I once served on a board with a co member of ferocious intellect, at times he and I arm-wrestled over finances and governance for an hour or so before reaching agreement. This was frustrating but never personal because the board had that magic ingredient RESPECT.
Without respect no team will function and without leadership no team will build and retain respect.
In summary there are as many differing “types of teams” as there are differing individuals and in theory no one type is better than another. The difference is in the quality of leadership, the clear communication of The Common Goal and the individual tasks task and most importantly the RESPECT & TRUST of the team members.
If you have respect and trust then yes you are part of a team. If its lacking you are a part of a group of people……..quite a different beast!
The Barking Mad Blog
SME Advice with Bite!
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