The majority of businesses are only concerned with gaining new customers, and spend most of their time and resources on this. However, you can avoid this trap once you understand the lifetime value of a customer and start looking beyond the sale.
You begin by focusing on acquiring great customers, and possibly in places you didn’t expect. Because you now have the whole picture, and understand the full value of a customer.
What is LTV?
Lifetime value of a customer, or LTV, is how much revenue you can expect from a customer during their entire relationship with your business. LTV is based on your average sale and length of a customer relationship.
In addition, LTV helps both you and your customers — because you’ll better understand how to utilize resources to keep your customers happy, and your customers will receive better service and value in exchange.
How can I use LTV?
Learning the LTV of your customers is essential for effective sales and marketing. Knowing how much revenue you can expect from your customers during the course of doing business with them, helps you make key sales and marketing decisions. In short, you know the max you can spend to acquire new customers.
Can I increase sales with LTV?
It’s not about spending the least to get new customers. It’s about spending the right amount to acquire great customers. Knowing the LTV of your customers gives you an advantage over your competition. Your competition may avoid what seems like costly sales and marketing not knowing that it’s actually a lucrative opportunity. But, since you know the LTV of your customers you can calculate your long-term profitability and take full advantage of what short-minded competitors may avoid.
But, like I said earlier it’s more than just getting the sale, and taking advantage of overlooked opportunities. It’s knowing how much to spend to keep a customer, because it’s always easier to sell to the customers you already have. So, by investing the time to stay engaged with your current customers, not only keeps them happy, it also increases your profits. This is because your customers are continuing to purchase from you for longer, making your LTV even greater.
You may decide to offer a discount to get new customers in the door, knowing you won’t break even with the first sale. But, since you planned a few steps ahead, and projected the average LTV of your customers is greater than the discount, you know this is a lucrative investment. LTV will also help you determine the size and amount of the discount.
For example, many gyms offer a free trial to get people in the door. This is often done because the lifetime value of that membership is much greater than the cost of the free trial.
Another reason to calculate the lifetime value of your customers is to determine if you can invest more in your business. Since you have costs of doing business with your customers.
For example an HVAC company has expensive labor and material, but these businesses stay profitable by working with their customers for the entire life of their HVAC system and longer.
Breaking It Down
Say a new customer hires them for service on an old unit. It may be roughly a $100 service charge, but that job leads to a maintenance contract for 10 years, at $200 dollars a year. Also, this customer needs additional service every few years, which roughly translates to another $800. Then the customer eventually needs the system replaced, as it is recommended to get a new system after 10 years. This adds another $9,500, bringing the total revenue to $10,600. If the cost of equipment and commission is less than %40, the company made a $6,360 profit over the course of doing business with this customer.
How do I calculate LTV?
While the lifetime value of a customer is an often-overlooked metric, it is quite simple to figure out. Basically, the average sale is multiplied by purchase frequency, (i.e., monthly, yearly) And, then this is multiplied by the length of the customer relationship.
(Average Sale X Purchase Frequency) X Length of Relationship
The initial investment of marketing, discounts, and other costs should be subtracted from this value to determine the net profit.
This simple formula is applicable to any business, from plumbers to ecommerce websites. To find these values, past customers and sales records can be used. Also, if you’re just starting out look into your competitors costs, or industry standards. It’s always important to use conservative values if no records are available, as it is very easy to get in the hole by using an inflated LTV.
Staying profitable by knowing your cost of acquisition
To determine your cost of acquisition you need to know how much you’re spending and how well your efforts are converting. This could be a complex process if you have a lot of marketing channels, and you need to attribute the sale to multiple channels, i.e. online, radio, or print. But, if you have only one channel, i.e. yellow page listing, you can easily attribute sales and determine how well it’s converting.
Breaking It Down
Let’s say you’re spending $25,000 a year in Search Engine Marketing, and making only 2 sales a month, or generating 24 new customers a year. If the average sale or purchase was $1,000 — it would seem at first glance that you’re losing money (e.g., $1,000 x 24 = $24,000 or net -$1,000). But, if your average LTV was $12,500 per customer you actually generated $300,000 in new business for you company, with a projected net profit of $275,000.
The example above is obviously nice round numbers, but if you ever find a specific channel generating this kind of profit, it’s time to double down.
Thanks for reading Lifetime Value of a Customer The Secret to Long Term Profits. You should now have a good understanding of LTV and the cost of acquisition. But, now you need to start looking for opportunities in your sales & marketing, and ways to increase your average LTV.