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.
By, Neil Steggall
The Barking Mad Blog
Business Advice with Bite