Understanding the value a customer has to your business over time is critical to making smart, cost-effective marketing decisions. Getting this right can light up your bank account. It will help you know:
- What market segments to target first
- How much you should be willing to spend to acquire a customer
- What types of customers you DON’T want to spend money on
- How much you should spend to retain EXISTING customers
- Which types of current customers you may want to “fire”
Your magic bullet is something called “customer lifetime value” (CLV), or just lifetime value (LTV). CLV is a business school concept that actually has real-life, make-or-break implications for small firms. Basically, CLV defines – in dollars – today’s value of the future profits your business can expect from a customer over the entire time they remain your customer. That time could be a day — or a decade. It’s important stuff; especially for small businesses that have been lured into the daily deals game and may be sacrificing long-term relationships for a few quick bucks.
CLV does take some effort. But it needn’t be hard. (Below, I’ll tell you about a handy online CLV calculator you can use for free.)
In simplified form, here’s how you get to it:
- Pick a time frame; say 10 years.
- Take the total annual revenue you expect from a customer – including expected changes up or down each year – and add them up.
- Subtract your expected costs of attracting the customer in the first place, your cost of goods sold, and the costs of servicing the customer each year.
- Apply a “discount rate” (usually 10-20%) to recognize that a dollar you hold in your hand today is worth more than one you get in the future.
One thing you’ll quickly discover is that common sense is correct: The longer you keep a customer, the more profit they produce. That’s true most of the time. Trouble is, not all customers are the same.
Oops! They cost different amounts to acquire. They produce different amounts of revenue and stay with you different lengths of time. They also require different amounts of care and feeding. If you don’t account for these differences, you’ll end up paying to acquire and keep unprofitable customers.
Bottom line: Segment your markets and spend more to acquire and keep your best customers. Think of it this way: Does it make sense to spend, say, $40 to attract a new customer (with a Groupon offer, for example) while spending nothing to keep a customer you already have?
Many business owners know a version of this as the 80/20 rule: That 80% of the profits come from 20% of the customers. Yet, conventional wisdom tells businesses to treat all customers alike. That’s a problem because all customers are not created equal. Being CLV savvy helps you focus your marketing methods and spending on customers who bring real value to your business.
Here are three more reasons to use CLV:
1) Your marketing budget is limited. It makes sense to deploy limited resources where they count the most – with customers who represent the highest profit to your business over time.
2) Even small percentage changes in customer retention produce large increases in profit. “Customer equity” in a business – which is the sum of all customer CLVs – jumps 50% with just a 10% increase in retention. Repeat sales are what send profits soaring!
3) Knowing CLV helps you see things in new ways. For example, while yellow pages may be out of favor, it might be that customers who find you there have higher CLVs than those who click a Google ad. Knowing this would help inform your marketing decisions.
Harvard Business School offers a free Customer Lifetime Value Calculator. Give it a try!
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About the Author: Daniel Kehrer, Founder and Chief Content Officer of BizBest Media, is a senior-level leader in digital media, content development and online marketing with special expertise in startups, SMB, social media and generating traffic, engagement and leads. He holds an MBA from UCLA/Anderson and is a passionate entrepreneur (started 4 businesses), syndicated columnist, blogger, thought leader and author of 7 business and financial books.