Written by David
29th April 2013 • 6 min read
Every company survives and thrives on new customers. Without a steady influx of new buyers, you’re headed for the business graveyard.
Of course, if you’re struggling to pull in new customers, you can survive for a while on your current customer base. But eventually your profits will fade away as your customers turn to your competitors, or their lifestyle changes and they no longer need what you sell.
Yet the best ways to pull in new customers quickly – direct response marketing, pay per click ads, or even social media engagement – can seem expensive, especially if you’re selling a £20 product and spending £30 on aquiring each new customer.
Does it ever make sense to spend more acquring a customer than he or she will spend when they come for a shopping spree in your store?
It can make sense – and here’s why.
How much is each customer really worth?
As soon as a customer makes a purchase from you, you’ve established a relationship. They’ve planted a seed of trust with your business, and they want that seed to grow as much as you do. It’s simple psychology. We all like to believe the decisions we make are good ones. So we act in ways that justify our past decisions. If we shop at a business once, we like to think that was a good decision, so we’ll go back there.
Because of this, most new customers will come back to your business again and again. Even if they find a cheaper option elsewhere, they know you provide what they want at a fair price, so they’d prefer to go with you.
In other words, many of your customers will become repeat buyers. Over time, shiny new customers will become friendly regular customers. As the years pass by, they’ll spend far more with your business than you spent on reeling them in with marketing or ads.
You can actually look at this in hard numbers. The key figure here is the “lifetime value” of your customers.
So, when you’re calculating the ROI of your marketing efforts, don’t measure it based on single sales from new customers. Work out the lifetime value of your customers. Then you know the real ROI.
Lifetime value also helps you decide how much to spend on customer retention. If your customers are valuable over the long term, it’s worth holding on to them, even at a price.
What’s more, even thinking about the fact that all your customers (including dormant customers) have a lifetime value encourages you to reach out to customers and former customers. You might find its more cost effective to redirect some of your marketing budget towards getting current customers to repurchase or increase their spending.
Some business gurus say the lifetime value figure is even more important than your break even figure. If you run your business on a subscription model – such as gym membership, a magazine, or rental software – it’s crucial.
How to Calculate Lifetime Value
Lifetime Value is the total net profit you make from a business relationship with your average customer.
There’s a reason Lifetime Value is rarely used: because it’s difficult to calculate.
To calculate the Lifetime Value of the average customer, you need to know how much each of your customers has spent with your business.
For businesses in the “real world” that’s tricky, though if you have a relatively small customer-base, it’s certainly possible.
Online, it becomes much easier, as you can use eCommerce software to manage customer relationships and track customer spending patterns.
The easiest formula for measuring lifetime value is as follows:
(Average value of a sale) x (Number of repeat transactions per year) x (average retention time in years)
For example, let’s say you sell a magazine subscription at £10 per month, so that’s 12 transactions per year. Your average subscriber stays with your magazine for four years. Your calcuation is:
£10 x 12 sales per year x 4 years
In this case, the Lifetime Value of your average customer would be £480.
Of course, if your business model is more complex, or if you sell a range of products, the calcuation will take a little more maths wizardry. But as long as you know how much an average customer spends each year, and how long an average customer stays with your business, you can work it out.
So how much should you spend on acquring new customers?
The answer depends a lot on “Lifetime Value”. When you’ve got some downtime pick up a calculator, and work it out.
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