Customer lifetime value calculates the total amount of revenue that a customer will bring in throughout the life of your relationship with them. The lifetime value of customers may seem difficult to determine on its face, but understanding how to calculate it is essential for any business looking to build long-term customer relationships.
That’s especially true when you consider that current customer satisfaction trends are at a 17-year low. Getting the most out of the customer relationship is crucial. In this article, we examine how you can do so by staying on top of these numbers.
Customer Acquisition Costs
To calculate LCV, you’ll need to consider three key factors: customer acquisition costs, customer lifetime revenue, and gross margin. First, you must know how much it’s going to cost to acquire your customers.
This will help you determine how much you’re truly making in the long run. To do this, add up your total marketing and sales expenses for a certain period of time (typically a year).
For example, say your company spends $5,000 on marketing and $1,000 on sales every month. You can read more about how to do this from your digital marketing plan.
In this case, your customer acquisition costs would be $60,000 annually. You can go further with it by dividing $60,000 by the number of new customers you’ve acquired.
Assuming you created 6,000 new customers from that budget figure, you can expect that you’re spending $10 to get each person on board with your product or service. Try it with your current budget and customer roster.
Customer Lifetime Revenue
The lifetime revenue of the customer should be your next determination. You can make this by looking at your total revenue and dividing it by the number of customers you currently have.
For example, if your company has a total revenue of $100,000 and 1,000 customers, each person is worth an average of $100 to your business. That’s pretty good customer lifetime value, especially if it only costs you $10 to get them!
This number will change over time as you get more or fewer customers, so it’s important to adjust your customer lifetime value model over time. And if you notice a dip, reexamine the value you’re providing.
This calculates the difference between your sales and what you’re spending on the goods or services you’re providing. Some call it “overhead.”
Once you’ve subtracted those two numbers, add them to the cost of customer acquisition. Subtract that number from your total revenues, and you’ve got a more inclusive sense of the profit each customer brings to your business.
Why the Lifetime Value of Customers Is Such a Vital Metric
The importance of customer lifetime value cannot be understated. That’s because:
- It helps you make decisions about how much to spend on acquiring new customers
- It provides a roadmap for growing your business by identifying opportunities to upsell and cross-sell existing customers
Calculating the lifetime value of customers also lets you see how you’re doing against the competition. For this, do research to find the average customer lifetime value by industry.
How Much Are You Paying for Customers?
That’s basically the question you’re answering when you calculate the lifetime value of customers. Get that number as low as possible, and you’re well on your way to running a profitable business!
For more business and finance tips, check out some of our additional posts.