Making money requires spending money, at least, that’s what they say. And yet, for some small business owners, a generous marketing budget just isn’t in the cards.
You can skimp on marketing, but it is a possibility you haven’t considered something that you should be thinking about…and that’s the lifetime value of each loyal customer you attract with your marketing campaigns.
It’s known it costs more to attract a new customer than it does to retain an existing one – but how much can really be considered affordable to spend in order to attract a new customer?
Knowing the lifetime value of your customers is the key to creating a workable budget for marketing. That number should dictate how much you spend. Spend too much and you’re losing money in the long run. Spend too little – and you’re missing out on an opportunity to grow your business.
The How To’s of Calculating Lifetime Customer Value
How do we calculate the lifetime value of your customers? Here is a simple five-step process to get to the number your looking for.
- Start with your company’s total revenue in the past year and divide it by the total number of purchases in the same period. The resulting number is your average purchase value.
- Next, take your total number of purchases in the past year and divide it by the number of unique customers who made purchases. The resulting number is your average purchase frequency rate. (Note: if you make a log of cash sales and don’t request an email, then this number may not be accurate.)
- Take your average purchase value and subtract the average purchase frequency rate from it. That gives you the customer value per year.
- Calculate the average number of years a customer continues to buy from you. If you’ve been tracking unique purchases this shouldn’t be difficult. This number is the average customer lifespan.
- Now, multiply the customer value by the average customer lifespan to get the lifetime value of your customer.
Let’s look at an example of raw numbers:
- $100,000 in annual revenue
- 250 purchases
- 150 unique customers
The average purchase value would be $400. Take that number and divide it by 150 to get your average purchase frequency rate, which is2.67. Next, subtract the average purchase frequency rate from the average purchase value to get $397.33 (aka. your customer value per year). If you kept your customers, on average, for 10 years, your customer lifetime value would be$3,973.30.
A simple example that illustrates the point. This business has a lifetime customer value of nearly $4,000.
Using Customer Lifetime Value in Marketing
Once you know your customers lifetime value, you’ve got a piece of information that can help you attract more customers and make better use of your marketing budget. But what does that mean in practical terms?
Here are some actionable ways to use your CLV to your advantage in marketing.
Identify the Most Profitable Customers
If unique customer data is being tracked, then it’s worth the time to crunch the numbers and learn about who your most valuable customers are.
For example, you might look at your LCV by:
- Age
- Gender
- Race
- Location
- Income
These basic demographics can help in performing a better job of targeting your marketing campaigns to the people who are most likely to be profitable to you in the long run.
Identify the Most Profitable Marketing Channel
You should also calculate your most profitable marketing channel based on the number of new customers you acquire.
Perhaps you have been running marketing campaigns on:
- Google AdWords
Crunching the numbers might reveal that your spending onGoogle AdWords is earning you a significantly lower return than your Facebook advertising. Knowing that can help you take the next step.
Increase New Customer Acquisition Spending
It costs more to attract new customers than to retain existing ones, but once the LCV is known, it can discover your new customer acquisition spending is on the low side.
Spending through the roof is unnecessary. However, looking at what you’re spending compared to the LCV you’ve calculated is something that can -and probably should- be done. Spending only a tiny fraction of the LCV to acquire a new customer may be worthwhile to spend a bit more in that area going forward.
Allocate the Marketing Budget to Maximize Customer Value
Your lifetime customer value might not be as high as you want it to be. The good news is that there are things you can do to increase it.
For example, say that you have learned that the people who follow you on Facebook are your most engaged and profitable customers. That’s great information to have.
Instead of sinking money into something that might not be getting you a big return, you can allocate more of your marketing budget toFacebook. Some if may go toward attracting new customers, but you should also spend some trying to get existing customers to buy more frequently and spend more money.
One way to do that is to offer return customers discounts or to create a loyalty program. If you can inspire your existing customers to buy more often, then you’ll be driving up your LCV every time they do.
At the same time, incentivizing your existing customers may also attract new customers to your business. You can encourage your followers to invite their friends to your page or allow them to share a discount code or coupon with their friends.
Your Customers Are Valuable
Every customer you have contributes to your company’s success and profitability. Understanding just how much each customer is worth to you can help you do a better job of attracting new customers, increasing their lifetime value, and maximizing your profits.