What Your Customers are Worth (and Why it Matters)
What is the value of a customer? What profit can they bring this week? This year? Over a lifetime? It may seem like a simple concept, but many small businesses have no idea what a regular customer is worth to their business. This creates two problems:
- Uncertainty about effective marketing. What is the number of new customers you’d like to attract and what is an appropriate budget to do that? Defining a customer value will guide your marketing strategies!
- Ambivalence regarding customer retention. With a metric for measuring customer values, you can navigate appropriate parameters for retaining them or expanding their business. Research shows that increasing customer retention rates by merely 5% increases profits by 25% to 95%!
Customer Lifetime Value
While there are many complex formulas for calculating a Customer Lifetime Value (CLV), a basic approach is to break calculations into five digestible portions, like this:
- Average Order Value (AOV). On the most basic level, AOV is calculated by how much money is spent per customer in a year, divided by how many orders are placed by that customer in that timeframe.
- Purchase Frequency (f). Take the number of orders/visits/transactions from the past year and divide it by the number of unique customers you had. The total equals frequency, or how often an average customer purchased from you.
- Customer Value (cv). The base value of a customer can be calculated by multiplying the AOV by the purchase frequency (cv = AOV * f). In this instance, the customer value is being calculated for one year.
- Average Lifespan/Time (t). A customer’s lifespan is how long they actively connect with your business before they move on or go dormant. This can be a complex calculation, but to keep things simple you can either give a broad estimate (an educated guess) or you can calculate an average based on a select number of known customers (adding the length of each of their commitments and dividing by the number of customers). For example: Total Length of Commitment/Number of Individual Customers = Average Customer Lifespan (t).
- Customer Lifetime Value (CLV). Now that you’ve got a general idea of a customer’s value for a year and the average customer lifespan, you can use these variables for a lifetime value: Customer value (cv) * Average Lifespan (t) = Customer Lifetime Value (CLV)
While this is a very simplified equation, even a ballpark CLV can give you a more accurate idea of how valuable each client is to your business. What should you look to spend in order to gain a customer? How much should you spend to extend their loyalty? A benchmark CLV will give you a helpful base for marketing, loyalty programs, and sales goals for the upcoming year. Take a look at a more complex approach Starbucks has taken to determine their CLV as a whopping $14,099!1
Your Customers Are Your Future
A customer represents the future of your success and your livelihood, and it will be difficult to thrive if you aren’t willing to risk or invest to attract new business. What are your obstacles to expanding your reach or enlarging your advertising? Has the uncertainty of direct mail marketing kept your business from growing? Why not rely on our expertise? We offer sophisticated, simple ways to reach a mass audience for an amount that works within your budget. Need a creative concept or help to carry it to completion? We offer prompt, knowledgeable service for every custom design mailing. Give us a call today!