Tweet

Why customer lifetime value is the most important measurement in your business

Guest post by: Peter Lawless

Article Overview: When I ask, all the people that I meet in business, if they know their top 10 customers, most proudly announce that they do. Then, when I then ask who their top 10 most profitable customers are, it is normally a very different look. Do you know? And why would you care? This article explores the importance of knowing the lifetime value of your customers and how to calculate it. This way, you can spot trends as they happen, and make the most from them.

Why customer lifetime value is the most important measurement in your business

How do you calculate your profitability?
You will need to apply some simple accounting rules in relation to fixed and variable costs. Stop yawning and stick with me, since this is important. OK, maybe you have a good accountant; they will be able to help you out – if not, get a new one!

To calculate your fixed costs, look at all the items that you spend money on every year. Things like; rent, light, telephone, salary costs, etc. When you have the total, then divide that by the amount of customers you have, and that is the amount you will assign as the fixed cost to each customer.

To calculate your variable costs, you will need to add up the cost of goods sold. Items such as; material costs, variable manufacturing costs, sales commissions, lead generation costs, service costs, etc.

This will give you a total cost of doing business, and what most companies do, is apply the variable costs the same way as the fixed costs and calculate an average margin. For example if you had turnover of €100, and your fixed costs were €30 and the variable costs for the year were €40, your margin would be €30 or 30%.

How do you calculate individual customer profitability?
You have your average margin, what you now need to do is to divide your customers into groups. Suggestions would be as follows;

* Top 5 revenue earning customers
* Middle 5 revenue earning customers
* Bottom 5 revenue earning customers
* 5 customers in each industry
* Additional metrics may include
* Location
* Number of employees
* Sales representative looking after them
* Products they buy

Once you have your rankings, then try and apply the above calculations to each segment. Apply your fixed costs as a proportion of revenue each customer generates.

Now apply the variable costs to each customer segment. Some products may cost more to produce. Some locations may cost more to service, and some of your larger customers may seek larger discounts, which can all eat into your margin.

Calculating the lifetime value of a customer
Once you have an average profit per segment, you can create the average profit per segment. Just by getting this far you will have obtained huge insights you’re your customer base.

You will finally need to look at how long your average customer stays with you, and how much they buy. So say customer X, has been with you for 6 years, has spent €500 with you, and the margin has been 20%. That means the customer has generated €100 for your bottom line.

That is the secret to successful business – knowing the lifetime value of a customer.

Now you know the Lifetime Value – what next?
Whatever the answer you come up with, you now will have the secret to multiplying your profits. Select the groups that deliver you the most lifetime value. With this information you can do the following.

* Work out how much you are prepared to spend to get a new customer that will deliver you €100. Use this as the basis of your marketing plan
* Love your existing customers in those segments, and continue to sell to them.
* Identify the least profitable ones, and either relinquish your attention on them, or find ways to increase the value they deliver to you.
* Use the information gained, to target your marketing and lead generation activities on similar types of prospects.
* Ask each one of them for two referrals, after all, since they are giving you so much profit, they must be happy!

The above exercise is one that should yield you massive returns on the time spent. However, once completed, you should seriously consider putting in a system, which tracks this information as you go on. This way, you can spot trends as they happen, and make the most from them.

Related Articles
  Lifetime Value of a Customer is Unlimited
  The "Customer Experience" versus "Customer Satisfaction"
  How A Simple Question Earned Thousands Of Dollars
  How Much Money And Time Do You Spend To Bring In A New Client?
  Making Sense of Customer Value

Article Tags: accountant, customer profitability, customer segment, doing business, fixed cost, generation costs, location number, marg, material costs, metrics, money, proportion, salary costs, sales commissions, sales representative, simple accounting, turnover, variable costs



Related Forum Posts
Re: How do you earn trust with an online business? - I think doing what you say you'll do, is the most important thing. If you tell them they'll have support within an hour....then you better do it. Being friendly and always letting them know that you are there when EVER they need you and then proving it, builds lifetime customers and friends. Having a great product doesn't hurt either.
Re: Do you have to have your own business in order to - I think you really have to go with your gut feeling. If you think it's a product that you can keep selling over and over (consumer) and never have to worry about not having enough business, then I say go for it. Do one product and do it well. But if the product is something they probably will only buy every 10 years or even just once in a lifetime, then you may be better off thinking the whole thing through before putting a lot of money into it. Most internet marketers tend to sell one product and then have several "up-sales" for the same customer that are in the same line. For example: their logic may be that if they'll buy one book about how to start a profitable pet walking service and it was a helpful piece of information, they'll buy another book about how to expand on that same business or how to teach the pets to walk without twisting the leashes. That's goofy.....but you get the idea.
Re: How do you make the most of your day? - Hi Tanny, This is an interesting thread you've started. My daily schedule runs through a weekly cycle and also a term/holiday cycle, and the Internet business side depends on my own energy and focus!! How many of my tasks I get done also depends on how many orders or customer enquiries need to be dealt with... I make a To Do list, usually over breakfast. The list is almost always longer than the day! Last year I read Stephen Covey's "7 Habits" and liked the idea of the four types of activity: urgent/important not urgent/important urgent/not important not urgent/not important The aim is to get as much time as possible for the "not urgent/important" category and cut out nu/ni altogether. He also recommends planning for a week. I do keep a weekly schedule, but I don't fill in all the non-teaching etc hours with my projects because too much "stuff" comes up, so I keep to a daily To Do list.
Company services - Hi, In addition of not providing a good service, we are loaded with the new technology telephone systems. Here in the UK we have automated telephone answering. It takes quite a while to get to the desired sevice, then all over a sudden your cut off. One has to start all over again. Sometimes it can add hours ie waiting or redialing. In addition, we have numbers, which can add costs to the phone bill. One number in particuliar, the company gets some money back. If it is a charitable company, it can benefit them. More often than not, it is a legitimat company. Does that sound familiar? How can we overcome these lengthy calls etc.? Many times I deal by email and often benefit from a quick and satisfactory service. Often they call me, which I appreciate. [quote="ChrisH":1b1ok76u]I am familiar with the reasons why they could have customer service issues. But, if there is another company who wants my business and will give me customer support, why waste my time with a company who doesn't offer support for me? Over the years, I've dealt with enough companies who didn't care they had lousy customer service. There have been times when I mentioned that I liked their prices and products etc - but other companies offered better service and that can be just as important. Far too many didn't care and had no desire to make any changes. I'd rather focus on doing business with the companies who support me as a customer and who show they appreciate my business. Chris [/quote:1b1ok76u] Regards Beat
Starting A Business - go get a customer! you can have a great idea but if you don't have a customer you'll never be successful. Build a product / service around someone who will pay you for what you can offer! It's the best way to build a business.


Share this article with your friends. Fund someone's dream.

Leave a comment below or share on the left and you'll help support entrepreneurs in Africa through our partnership with Kiva. Over $50,000 raised and counting - Please keep sharing! Learn more.

Tweet

Newsletter

Get advice & tips from famous business
owners, new articles by entrepreneur
experts, my latest website updates, &
special sneak peaks at what's to come!

Name:
Email:

Popular Articles

Getting The Media Attention You Deserve

What Makes an Extraordinary Business Consultant?

Small Business Internet Marketing

Suggestions

Email us your ideas on how to make our
website more valuable! Thank you Sharon
from Toronto Salsa Lessons / Classes for
your suggestions to make the newsletter
look like the website and profile younger
entrepreneurs like Jennifer Lopez.