Determine the Lifetime Value of Your Customer

Often when businesses look at a customer they see and focus on only the value of the first sale. When Alice buys a product worth $20, many companies see Alice as being worth $20 in revenue. They do not see her as worth more than that unless she purchases more at a later date. They do not predict that she may or may not be worth more than her intial sale.

Let's assume D Company looks at customer value this way. D Company misses a lot of value by overlooking the repeat sales that a customer may make over the lifetime of purchasing from them.

If the numbers were more accurate, merchandising budgets, marketing budgets and operating budgets could be adjusted to become more productive and more profitable.

On closer observation, the true value of Alice is the value of all the purchases she has made in the past plus the value of all the purchases she is likely to make in the future (discounted to the present). This is called the lifetime value (LTV).

According to Ryan Allis, author of Zero to One Million, "The essence of what you must know here is that to obtain the lifetime value of an average customer multiply your average sales by the average number of times they come back. You can estimate these figures to come up with a rough lifetime value figure." He continues on to say that, to estimate your lifetime value of an average customer, the formula is:

Estimated Average Lifetime Value = (Average Sale) x (Estimated Number of times customers reorder)

LEARN BY DOING SECTION: Go ahead and calculate this figure right now.  Try it once to get the idea and then come back and try it for different customer segments or different areas of your business.

1. Your estimated average sale is _______________.

2. The estimated number of times customers reorder is ________________.

Now, multiple figure one by figure two to get _________________. This is your estimate for the average LTV of a customer.

It is a different way of thinking than the original "value of a first time buy only" view point. Some businesses are more prone to getting repeat customers than others.

With customer loyalty programs, businesses that traditionally did not see as much repeat business have seen record numbers. Hallmark's customer loyalty card program helped them to remain strong as e-cards became popular. Coffee shops compete all the time with the "buy nine get the tenth" coffee free cards. Even hair salons are using that approach now.

As the cost of obtaining a new first time customer continues to be a significant investment, usually more than that needed to make a sale to a repeat customer, the value of knowing the lifetime value of a customer becomes more important. If the costs are much lower to focus on repeat customers, the business may keep sales approximately the same, lower its costs, and make a better profit.

Knowing the estimated average lifetime value of your customers puts you and your business at an advantage. It helps your business to be more accurate in its efforts, while at the same time, makes it more competitive.

Large retailers like Macy's spend significant budgets on private label credit cards that a customer may never use or only use one time for the discount they received as incentive to use the card the first time. The reason is because consumer behavior has shown that the average customer who signs up for a private label credit card spends several hundreds of dollars more per year than the average customer who does not. For more information on private label credit card usage, see The U.S. Market for Private Label Credit Cards, 5th Edition, Global Information Inc.

Not only is it worth it to consider the value of calculating the average estimated LTV of a customer, looking at how other businesses create customer loyalty may prove valuable as well.

By Jean Lewis.