You obviously know the value or worth of your products and services. But do you know the value or worth of your customers?
If you don't, you need to. It's easy to calculate, and it's crucial for your success.
The lifetime value of your customers focuses on their long-term significance to you and your business. While each transaction of every customer is important, it's the multiple or lifetime-purchase decisions that yield your greatest profits.
To discover the lifetime value of a new customer, you need only a few numbers:
1. The size in dollars of your median or typical sale to this customer.
2. The size in dollars of your typical sales over a certain period of time, (a month, a quarter, a year, etc.).
3. The number of years, prospective, you'll serve this customer.
4. Your average gross profit value (AGPV) or profit margin, (the percent of profit you make on each sale).
5. Your acquisition cost, (How much it costs you to acquire or "land" this new customer. You may consider the cost of advertising, direct outside sales, public relations, promotion, trade show exhibits, etc.)
You might not know all of these figures immediately, yet it's worth investing a little time to discover what they are. To show you why, let's go through the lifetime value equation with an example. Imagine that:
1. The size in dollars of your typical sale is $5,000.
2. The size in dollars of your typical sales over "a year" is $20,000. (Your typical sale with a typical customer is $5,000 per quarter.)
3. At a minimum, you determine, you'll service this customer for at least another 10 years.
4. Your AGPV or profit margin on each $5,000 sale is 25 percent, or $1,250.
5. Your acquisition cost to acquire a customer is $1,500.
Now let's plug these numbers into the lifetime value formula:
Median or typical sale: $5,000
Annual sales: $20,000
Years of prospective service: 10
Annuitization: (years of service multiplied by annual sales) 10 x $20,000 = $200,000
AGPV/Annual: 25 percent ($20,000 x 25 percent = $5,000)
Years of prospective service:
10 x $5,000 = $50,000
Less acquisition costs: -$1,500
Lifetime value: ($50,000 – $1,500) = $48,500
How often would you invest $1,500 (in year one) to get back $48,500 over 10 years? All the time!
There are several advantages to knowing the lifetime value of your customer:
1. It helps you and your people focus on the long-term.
2. It emphasizes that your ability to "peak your profits" may not happen on your initial transaction, but it will with many future transactions.
3. It allows you to positively control and better understand or justify your marketing and advertising expenditures.
Let's take a look at the last advantage. We'll go back to our example. Imagine now, you own this business and you advertise your gizmos in a magazine.
The cost for the ad is $10,000. The ad generates 100 leads, but only two $5,000 sales. On the surface, it looks like the ad is, at best, a "break-even" proposition.
This might be your analysis, if you didn't know the lifetime value of your customer. But now you know these customers should each buy another three times over the next three quarters. And they should buy another 36 times over the next nine years.
Therefore, despite a $10,000 investment for the original ad, you'll still have a profit of $75,000 over 10 years from these two customers. Even if your acquisition cost is significantly higher, it's still a wise investment because of the lifetime value of these new customers.
Now, if you're a cynic, you might say, "Hey, nothing is guaranteed. These decision-makers could die tomorrow. Their relatives could open competitive businesses and steal away these accounts. Who knows if they'll still be loyal in 10 years?"
You're right, all these things could happen. However, the following could also take place:
• You serve these accounts for more than 10 years, increasing your profits.
• The size of these orders increases in dollars, increasing your profits.
• Your customers buy more often than four times per year, increasing your profits.
• Your customers refer you to several others who then become long-term customers, too. Not only do you get the benefits of lifetime value from these new customers, but you do so at a significantly reduced acquisition cost, increasing your profits.
By knowing your customer's lifetime value, you can also begin to peak your profits for a lifetime!