Fewer than one businessperson in a thousand really thinks in terms of the incremental lifetime value of customers, or even knows how to calculate such a figure. Yet both the calculation and the idea itself are easy and yield enormous benefits.
For one thing, if you know the incremental lifetime value of a customer, you can determine in advance how much you can afford to spend to acquire that customer. Moreover, you can reliably predict your cash flow well into the future. A case in point comes from a coffee roasting company with a mail order division.
The company ran an advertisement that cost $12,000. The ad invited potential customers to accept a free coffee maker valued at $51.95 if they bought a sampler selection of fresh roasted coffee blends for $34.95. Part of the deal was that the customers simply consider a “‘til further notice” home delivery service. An order of their preference would be sent to them monthly and charged to their credit card. (They were under no obligation to sign up for the “‘til further notice” agreement. They merely had to consider it. And regardless of their decision, they could keep the coffee maker.)
“Until further notice” arrangements mean that the arrangement continues until the customer gives the company notice to discontinue sending the product or service. The hard cost of supplying the free coffee maker and the sampler pack leaves a net profit of $1 per response. When you factor in the $12,000 for an advertisement, you’d immediately conclude that 12,000 responses were needed just to break even, wouldn’t you? Based on that, you’d probably think the coffee company would be crazy to do it, wouldn’t you? But let’s look more carefully at the numbers. For each person who finds the “‘til further notice” arrangement to be a convenient way to buy, the average annual gross profit is $245. So the response rate required to break even falls from 12,000 people to just 49! That is, the coffee company would recover the upfront investment for the ad within one year if only 49 people responded.
When you also know the average customer continues to buy from you for at least three years and refers an average of 0.2 new customers, the numbers become even more interesting. The lifetime value of a customer from this promotion, then, is at least $882. So by testing, you discover that 300 people respond to the offer: 100 say, “Thanks for the gift but I don’t want any home delivered,” and another 100 say, “Thanks for the offer but I’ll call you if I want more.” But 100 say, “Thanks, I love this arrangement and I love your coffee—please continue to send it to me.” In this situation, you have just parlayed $12,000 into an $88,200 return over a three-year period! Do that four times per year and it’s a pretty neat way for the coffee roasting company to create a return of $352,800 from a $48,000 investment.
This kind of information is invaluable, isn’t it? Imagine what could happen for your business if you knew absolutely that from every ad you ran, you’d win a certain number of new customers at a certain value to you! Your confidence in your business would increase and the ability to make marketing decisions would be much easier. You’d know—beforehand—whether running a certain ad or direct mail was worth it. What a change! Not only do lifetime values show you whether advertising in various mediums is worthwhile for your business, they also show clearly that nurturing those customers is crucial.
If you know your customers are worth a certain value to you over time, it’s not enough simply to win the customer and hope for the best. At that point, it becomes imperative to keep winning that customer over and over again. That way, you cement your relationship with your customer and ensure the fruition of that lifetime value. To do this, it’s important to “nurture” your customers to improve or keep your current retention rate. (Your retention rate tracks the number of customers you retain versus those you lose due to service, quality, or product issues.) Once you know the lifetime value of your customer, you can work to increase it. You can design a strategy to increase your average sale, to get your customers to deal with you more often during a year, and to keep them dealing with you longer. Another benefit of tracking your lifetime value is definitely worth mentioning. If you ever wanted to sell your business, your ability to show a prospective buyer an incremental lifetime value projection—like the one above—could go a long way toward securing a sale.
Paul Svendsen is a part-time instructor at COCC and president of Axia Valuation, LLC. He can be reached at 389-4740.