In general terms, a customer lifetime value is a prediction of all the value (aka sales) your business will receive from its full relationship with a customer. You don’t know for sure how long your relationship with any given customer will actually last, so you make an estimate. The estimate is usually based on your historical customer sales data. It is a calculation of all the products in your product funnel if a customer was to start at the top of the funnel and purchase everything in the funnel.
The Customer Lifetime Value is an important indicator of future revenues. It is also a good measure of the effectiveness of your marketing investment dollars.
You can start using your customer acquisition dollars in ways that optimize that spending for value rather than just minimal cost. As noted by Harvard Business School Publishing, it can also be used for identifying the correct service levels for your distinct customer groups.
Calculating your Customer Lifetime Value
Calculating the lifetime value of a customer isn’t that complicated. The basic formula is average sale value multiplied by both the typical repeat transaction total and the average time you retain a customer. If your customer retention period is 12 months and they make four purchases for $30 each on average, the total Customer Lifetime Value is $120. Remember it is not just repeat purchasing of the same or similar products it also includes selling the other products in your funnel.
Customer acquisition and your Customer Lifetime Value
Naturally, if you’re getting an average of $120 per customer, you shouldn’t be spending $200 to acquire them as that means you’re actually losing $80 for each new customer. Once you’ve calculated the lifetime value of a customer, you can decide how much to spend to acquire each customer.
The two common acquisition strategies are allowable acquisition cost and investment acquisition cost. Under an allowable approach, your amount spent per customer for each marketing campaign is set below the profit you’re going to make on your first sale. This is a short-term strategy that is ideal when cash flow is one of your concerns.
With investment acquisition cost your per customer acquisition spend could mean a loss on a first or even second sale. This is okay if you have the resources and cash flow to handle the loss associated with this long-term marketing plan.
Customer Lifetime Value is a very important indicator of future sales that many beginning entrepreneurs don’t even consider. Not only can it help determine customer acquisition spend, it should drive your marketing activities. Selling down your product funnel for many of us is critical to increasing revenues. It also can help to identify the need for the addition of new products.
What is the Customer Lifetime Value for your business? How can you increase your it?