How Much Is Your Customer Worth?
Jul 27th, 2008 by admin
Try this quick quiz:
- How much are your customers worth?
- What is the value of your customers (best and worst)?
- How much is a new customer worth to your company?
- How much should your company spend trying to attract and acquire new customers?
- How much should your company spend trying to retain existing customers?
- Which acquisition sources generate the best customers?
- Which offers attract the best customers?
If you are unable to answer any of these questions accurately, you’re with a large number of marketers and entrepreneurs. The majority of business owners do not understand that marketing is more than generating new customers. It’s also about keeping those you have – and keeping them for life. Every one of your customers represents incredible potential, and you need to know exactly how much in order to make informed and knowledgeable business decisions.
Enter the concept of
Customer Lifetime Value (LTV)
Relationships are built on value and service. The only clear way to quantify the value of a customer relationship or the value of repeat business, is to determine the Lifetime Value of a Customer (LTV). The basic definition of LTV is the total amount of sales revenue the average customer contributes to a company over the life of the customer-business relationship, less the amount the company spends to acquire and retain this customer. The difference between the two values is defined as the Customer Lifetime Value.
Measuring LTV
Measuring Customer Lifetime Value is useful because it enhances understanding of product profitability, customer behavior, expense behavior, the way in which customer relationships evolve and how each of these factors are affected by product changes and the economy. There are, however, certain points to keep in mind when determining LTV:
- LTV is usually measured over a long period of time, typically four or more years.
- A large amount of historical data is required to accurately measure LTV. Some of this data includes: customer transaction history, item level detail of their purchases, how much they have spent, when they have purchased, how many returned items, where they have purchased, why they have purchased (promotions, holiday offers, etc.), financial measures, cost of goods, variable/fixed costs, promotion history and details, etc. If detailed information in any of these data categories is not available, estimates are often used.
- It is possible for different types of customers to have different values, so measuring individual customers and customer segments is very common.
- The intent of LTV analysis is not to count pennies, but rather identify repeat customers that can be counted on.
LTV may be estimated by the historical or forecasted approach. The historical approach takes all available historical data on a specific customer(s) and tracks all revenue and costs associated with them. The forecasted approach, however, takes only recently observed trends of customer behavior and forecasts them into the future. The historical approach will present the most accurate data, but where the economy is changing so rapidly, the data from the forecasted approach is sometimes more useful.
While there are many complex methods for measuring LTV, the most basic equation is as follows:
- Average price per sale (total sales revenue less sales expenses, such as advertising, marketing promotions and cost of goods sold, divided by the total number of sales)
- Average number of times the customer will purchase over a one-year period
- Calculate the amount made from the customer in one year
- Multiply the one-year amount times the number of years customer is likely to purchase (which could be obtained from residency statistics available from the Bureau of Census)
Example: Lifetime Value of a Customer – Clothing Outlet
- Average sale amount (less relative expenses, etc.) = $34.00
- Average number of purchases per month = 3/month
- Average monthly revenue = $102.00 ($34.00 X 3)
- Average yearly revenue = $1,224.00 ($102.00 X 12)
- Residency = 7 years
- The Lifetime Value of a customer = $8,568.00
This may seem like a low figure for a seven-year period for one customer, but the number of referrals the satisfied customer sends into the store can again multiply that figure.
Customer refers two friends and five family members:
7 X $8,568.00 = $59,976.00
The goal of LTV projections is to guide your marketing and strategic decisions and to enhance the total Lifetime Value of your customer base, therefore increasing revenue and profits. When you realize the value and earning potential from just one of your customers, you will clearly see how much your customer is worth to your business.
