Why Lifetime Value Matters

Customer Lifetime Value

What is a Customer Worth to You?

Do you know how much a customer is worth to you?  It's not that hard to estimate and it's a key piece of information you need to make good decisions.  Knowing the average lifetime value of your customers tells you;
  • How much marketing your can profitably spend on acquiring a new customer
  • How you and your staff should treat customers (it's not just about the transaction at hand)
  • What you can (and should) spend on fixing a customer's problem in order to keep them

So how do you measure the lifetime value of your customers?  Here's an easy way…

  1. Calculate or estimate your average order value
  2. Multiply this by the average number of times a customer buys from you per year
  3. Multiply this by your average profit margin
  4. Multiply this by the number of new customers each customer refers to you (per year)
  5. Multiply this by the average number of years each customer stays with you

For example, a hairdresser might find that;

  1. Their average order value is $70 (ranges from $30 to $200)
  2. Most customers come about 6 times a year so revenue per year is $420
  3. Profit margin is about 60% so profit per year is $252
  4. On average, each customer refers 1 new customer a year, so their value becomes $504
  5. On average, each customer stays for 3 years (before moving or changing salons), so their lifetime value is $1512
If this hairdresser runs advertising (or for instance joins Word Of Mouth Online's Happy Customers Program) for $500 a year, technically it only needs to deliver one (1!) new customer to make this a worthwhile investment.  (Obviously the more the better and hairdressers typically get 50 new customers a month, but you can see the point.)
If you need an even easier way of calculating Customer Lifetime Value, try this;
  1. Take your annual revenue
  2. Divide this by the number of customers you served in the year (this incorporates customer referrals)
  3. Multiply this by your average profit margin
  4. Multiply this by the number of years each customer stays with you
MoneyAnd if you want to get really fancy, you can calculate the Lifetime Value by different customer segments.  This can tell you which customers deserve more of your attention or warrant a higher marketing spend.  (Eg. The hairdresser might find that women who use blond colour foils are 3 times more profitable than the average customer.  So yes, we do deserve good coffee or champagne while we wait!!!)
Understanding where the money comes from is key to making more of it!

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