If you are going to spend money to get new customers, it’s pretty important that you know what they are worth to you.
Do you know what a customer is worth to you?
There is a calculation called “lifetime value of a customer” that I’ve used extensively with consulting clients and in my own businesses to find this out.
Lifetime value of a customer tells you how much profit you earn from an average customer over their lifetime as a customer of your business.
This number is crucial in the direct marketing industry as it is extremely rare to acquire new customers at a profit or even breakeven – so we need to know what we can afford to pay to get a new customer.
If your average lifetime value of a customer was $3,000, it would make sense to “buy” as many customers as you could if you could get them for $300 wouldn’t it?
Well, this is how the direct marketing industry works, but it makes sense for every other industry too. Without this information you could be making some big mistakes.
Let’s say you ran a marketing campaign to get new customers and you made $10,000 in sales but the campaign cost you $15,000. You probably wouldn’t do it again because you’d consider this to be a failure, wouldn’t you?
But, what if that $10,000 in sales came from 20 new customers? And, if your lifetime value of a customer was $3,000, those 20 customers are worth $60,000 to you in
profit and only cost you $5,000 ($250 each) to get!
That’s a huge success, not a failure!
You can see that not knowing this number for your business could cost you thousands of dollars of lost profits and cause you to make the wrong decision about your marketing and advertising programs.
I’ve had clients who stopped programs that were extremely profitable because they didn’t understand how to interpret the results. (the example just mentioned is one example)
Here’s how to calculate this important number for your company:
1. Divide your annual sales by your number of customers to get the average annual sales/customer
2. Multiply this by your average gross profit percentage to get the average annual gross profit/customer
3. Estimate how many years you retain an average customer. (You can calculate this if you know how many accounts you lose each year – divide that number into your total number of customers to get the number of years an average customer stays with you)
4. Multiply the profit in step 2 by the number of years in step 3 to get your estimated lifetime value of a customer.
If you have multiple product lines or services, you should have a different LVC for each. Some of your product lines or types of customers might be much more valuable than others and it pays to know.