Customer Lifetime Value

By: Dave Sunday November 1, 2020 comments

How much is a customer worth?

This is a fundamental question, especially for small businesses.  Having fewer customers means that each one has a proportionally larger impact on your business.  Good customers can eliminate your cash flow worries and keep you going in hard times, and bad customers can drain more of your time and resources than you can afford.

But how do you calculate which customers are “good” or “bad,” or somewhere in between?  Most business owners have a sense of this, but backing up your intuitions with some calculations and data could surprise you.  Some of those “good” customers might be more valuable than you realize, and perhaps deserve more personal, attentive service.  And those “bad” customers could actually be causing you to lose money.

Having good insight about the value and profitability of your customers can help you refine your business processes.  These are just a few of the major decisions that benefit from having good data about customer value:

• Budgeting marketing campaigns
• Evaluating sales process
• Qualifying leads
• Segmenting customers
• Allocating time for customer support

First, some definitions

Calculating the value of your customers can be a little tricky, and there’s lots of ways to go about it.  Here are the two we’ll be covering:

Customer Profitability:

This is the simpler of the calculations, focused on looking at your past transactions with your individual customers.  Pretty simply, it’s the difference between the revenues generated from that customer and the cost of acquiring and maintaining them.

Customer Profitability = Total Customer Revenue - Total Customer Costs

The only difficult part is figuring out how to calculate customer revenue and customer costs.  Ideally, you have software tools that make it easier.  Customer revenue is relatively straightforward – simply add up all the total purchases from that individual customer.  AllProWebTools does this for you in one of our reports. 

Customer costs are tougher, as you have to take marketing, sales, cost of goods sold, and support time into account.  Start by shooting for a rough estimate, to make sure you’re at least in the ballpark of profitability for each customer.

Customer Lifetime Value:

This calculation is forward-focused, allowing you to estimate the net profit for your entire future relationship with a customer.  This has the potential to be a very complex calculation, and it’s beyond the scope of this blog post to cover it all.  You can learn a lot more about customer lifetime value and how to calculate it here.

Who Can Use These Values?

Understanding customer value is just as important for small businesses as for larger businesses.  In many ways, small businesses are more sensitive to really good or really bad clients, so it’s crucial to be aware.

Customer Lifetime Value is often used in relationship-focused businesses (coaching, B2B services, etc) but can be used for transactional-based businesses as well, if you have a lot of repeat customers. 

Why Are These Values Important?

Understanding customer value over the long term helps shift your focus from quarterly or monthly profits to the long-term health of customer relationships.  Rather than quickly acquiring customers at a low cost that will yield a low lifetime revenue, look for customers that take more time and resources to acquire, but which have a very high value.  This is one of the most important steps in becoming a growth-focused business, rather than a reactive, struggling one.

This perspective on customers also encourages you to treat and manage customer relationships as assets.  That means taking care to follow up, setting reminders and even automating check-in emails.  It also means tracking all your past interactions and keeping detailed notes.  Technology can help empower you to reach out and make those personal connections by removing the stress, or the struggle of remembering from the equation.

How Do I Apply Them?

Here are my top 5 applications (explained very briefly) of customer profitability and customer lifetime value:

1. Knowing how much a customer will give you in revenue over the course of your relationship helps to calculate the upper limit on spending to acquire new customers. This includes both your sales and marketing efforts.

To calculate your average marketing spend per customer, take the total spent during a given period, and divide it by the number of customers acquired during that period.  Add to that the value of the hours your sales team spent converting that one customer, and that’s your customer costs.  That number needs to be less than their projected value, or else you’re spending too much to acquire new customers.

2. Customer value also helps you evaluate the quality of your customers, so you know how to prioritize and segment customers. For example, if you have a long-term customer who makes frequent purchases, you might want to offer her a special coupon, or ask them to refer friends. You might tell your customer support team to give her extra time and consideration, because you know that any time spent helping them, they’ll pay back to you in future orders.

For clients that take up a lot of time and resources for little return, you might want to start charging for support time, or set a limit.  When creating boundaries with needy customers, it’s important to be fair, but firm.  Your time has a value, and you shouldn’t feel bad for enforcing that fact.

3. If you look a little deeper into your best customers, you might be able to find some common traits that star customers all have. These are like gold for your sales and marketing efforts, as they will help you acquire more high value customers. Create a vivid customer persona that will help you target your ideal customer, and start targeting your sales and marketing materials to attract them in particular.
4. Once you have a good grasp of customer value based on revenue versus costs, you’re ready to expand the concept. Look for opportunities to increase value by turning customers into brand advocates or affiliates. By bringing in more business, their customer value skyrockets, which means you have more time to spend making sure they’re 100% satisfied.

Calculating customer value may seem cynical, but the truth is, you can’t afford to ignore it.  As a small business owner, your time is limited and valuable.  Stop wasting it on customers that aren’t giving you a profitable return on the time you invest in them.  This will free up that time to be the best you can be for the customers, current and future, that will take you to the next level.