It might seem pretty basic, but most small business owners don’t know the answer. Many just go with their gut. When it comes to advertising or marketing, this is really a fundamental question that should drive any of your advertising or marketing campaigns. Without knowing how much revenue the average customer brings in, it will be hard to tell if an advertising campaign is successful. Even before that, how would one budget for or plan a campaign. Another consideration, suppose an opportunity to acquire an additional customer would come at a cost, or require some kind of investment. Only by knowing what a customer is worth can the business owner evaluate the opportunity. For example, spending $1000 to gain a customer might be very profitable for one business yet lead to bankruptcy for another.
How to calculate the value of a customer
It’s clear that keeping customers and developing customer loyalty brings remarkable value to a company. Certainly, it is one of the primary reasons behind any firm’s success. And most all owners and employees know customers are one of your most valuable assets. But just how valuable are your customers? According to a 1994 Harvard Business Review study, Putting the Service-Profit Chain to Work, found “an increase of 5% in customer loyalty can increase profitability by 25-80%.”
While this statistic emphasizes the importance of customer loyalty, it is even more helpful to understand exactly how much a customer is worth to you now. This is also called the “Lifetime Value of a Customer.” There are numerous ways to calculate the lifetime value of a customer to a company. No matter the measure, producing a concrete dollar figure gives you a tangible point around which to design customer retention strategies, promotional campaigns, and even bonus plans. (Note: The following calculation does not determine profit, rather the overall customer value.)
Here’s a quick way to determine the lifetime value of your customers.
1. What is your average sale or average amount of money a customer spends per month? (Simply add up your total dollar sales for a year and divide that by the total number of sales transactions you completed.)
2. How many times a year does an average customer buy from you? (Take your total number of sales transactions for a year and divide it by the total number of customers.)
3. What is the expected number of years a customer will use your services or buy your products?
4. How many people per year does your average customer tell about your company? (You may have to guess at this one. It’s probably between 3 and 12. Generally, the better your customer service, the higher this number will be.)
5. What percentage of these people actually become customers? (Usually between 20% and 70%.)
Let’s apply this calculation to a local personal coaching business. If each coaching session is $150 and the average customer has two sessions a month, the gross sales per customer is $3,600 per year. Estimating that a customer stays with their personal coach on average for five years, the lifetime value of this customer, before referrals, is $18,000. Customers that are seeing results from personal coaching will more than likely tell their friends. The power of positive word of mouth magnifies the value of each customer. If we conservatively estimate that each customer tells ten people and 20%, or two, become customers, the gross sales from referrals is $36,000. Therefore, the total lifetime value of a customer is $54,000 (the gross sales per customer plus gross sales from referrals)!