Measuring Your Customers' Acquisition and Lifetime Value
Learn how to measure your customer’s value.
Creating a successful business model and solid marketing strategy relies heavily on your understanding of the cost to acquire new customers and measure a customer’s value. Calculating the health of those relationships can help you identify new ways to grow your business and increase market share.
“A customer’s value is averaging the value of each transaction that a customer makes over a period of three months or a year,” explains Jessica Oman, planner-in-chief at Renegade Planner, a firm that helps startups develop business plans and investor pitch decks.
It’s insightful information, but Oman says it doesn’t consider customer loyalty, repeat purchases, and the potential for referrals. Understanding the lifetime value (LTV) of your customers is a more detailed calculation of the net profits that a customer produces for your business over the period that they are in your sales funnel, she says.
Understanding LTV helps you:
- Make predictions about how your customers will spend in the future
- Create more targeted marketing campaigns
- Identify new customers
- Identify which product lines should be cut or promoted
- Gain better insights on customer retention
How much is each customer worth to you? What are you willing to pay for a new customer? Not sure? Let’s walk through this exercise and find out.
Calculating Customer Lifetime Value
Step 1. Estimate how long a customer will be in your sales funnel.
For example, imagine you own a dog toy store and most of your clientele comes from the local neighborhood. You can estimate that the average lifespan of a dog is about 10 years and most people live in your community for five years. Their potential lifetime value can be calculated over a five- or 10-year period.
“The difficulty comes in deciding how long that person will actually be a loyal customer to you,” explains Oman. “That’s subjective and we can’t get that number right every time, but we have to base it on the market research that was done.”
Step 2. Outline how often you think that customer is going to buy from your business over that period of time. Based on the market research you’ve done, that might be once a month, says Oman.
Step 3. Calculate how much they will purchase each time.
For example, if a customer comes in once a month and spends $15 per trip on average, you can easily calculate how much revenue you’d generate from the lifetime of that customer relationship.
Step 4. Do the math: (Average Retention Time in Months or Years a Typical Customer is in Your Sales Funnel) X (Number of Repeat Purchases) X (Average Value of a Sale)
Although it can be difficult to determine the exact figures, “the more often you’re doing those metrics, the better decision making power you have,” Oman says.
Tips for Improving Customer Lifetime Value
If customer retention is a struggle, “encourage them to make multiple purchases,” Oman advises. You can do that through your marketing or email list and offer them special promotions or discounts. “Give them a reason to come back to you,” she says.
Try to upsell the customer; a tactic to encourage repeat purchases. “Bring your customers through your sales funnel starting with a very small purchase and once they trust you introduce them to more expensive and value offerings.”
Once you have an idea of the lifetime value of your customer, you can make better decisions on how to optimize your marketing efforts and how much to spend to acquire that customer.
To figure out your customer acquisition costs, divide the total cost associated with the acquisition by the total number of new customers you gained within a specific time period.
The cost to acquire should be less than the profit you make from the sale.
“You want to make it cheaper to acquire and you want to make the customer value higher at the same time,” says Oman. “Get those two numbers as far apart as possible.”
Although these calculations are predictions, they are two of the most important metrics to reference when building a viable business. They help you determine the success and future profitability of your company, and they can reveal innovative ways to build customer loyalty, identify new markets and determine which customers to invest in.
Getting new customers is important, but so is protecting everything you’ve worked for up until this point. Contact an American Family Insurance agent to find out how you can set your company up to withstand the unexpected and continue to thrive in the future.