My buddy Phil Bernstein sends out a free newsletter to his clients and colleagues, and anyone interested in improving the quality of their advertising. I think highly enough of what Phil has to say that I agreed to sponsor his newsletter. This week, Phil shared his discovery of an online resource that enables anyone in sales or business to calculate the lifetime value of a customer. He writes:
A gentleman of my acquaintance recently got a promotion at his job. He and his boss had discussed the opportunity several times before he got the offer, and he'd had time to do some research.
The research had convinced him that the offer was lower than the median salary for the position. He suggested that since he wasn't planning to do below-average work, he shouldn't receive below-average pay.
The boss asked him to bring in his research, and a week later the offer was sweetened by a thousand dollars. He then accepted the new position.
I congratulated him on his diligence -- a little extra effort had gained him an extra thousand bucks.
He corrected me, pointing out that the extra effort was worth quite a bit more than that:
- It's an extra thousand dollars every year he works for the firm. If he stays five years, that research will get him an extra $5000.
-- Any raise or bonus he gets will be based on a number that's $1000 higher.
-- And if he ever applies for a job elsewhere and they ask him how much he made, he can report the higher figure.
The conversation got me thinking about the way we calculate the return on our advertising investment. Many businesses fall into the same trap I did: judging the value of a new customer based on the value of that customer's initial purchase.
If we spend $100 to acquire a new customer, and that customer spends $75, it looks like we lost money. In fact, the true ROI on that $100 depends on the Lifetime Valueof the customer.
If you know:
- Your average transaction amount
- Your average gross margin
- The number of times a customer buys each year
- Your retention rate, or how many years an average customer stays
- The average cost of acquiring a customer (basically, how much you spend divided by the number of new customers you attract)
... you can calculate the lifetime value of each new customer.
You can get fancier than that if you want to factor in the value of referrals, upselling or cross-selling. But the information above will give you a pretty good picture.
And through the miracle of the internet, you don't even have to do the math yourself. The folks at Harvard Business School (a school I have never attended, although I once drove by the campus) have posted an onlineCustomer Lifetime Value Tool. Just plug the numbers in and watch it work.
Once you know where you stand, it raises some interesting follow-up questions:
1. Would it make sense to "go negative" -- lose money on the first transaction in order to profit on the lifetime value?
2. What can you do to increase the average transaction? Are there additional products or services that new customers might purchase if they were offered?
3. How often are you in touch with your existing customers? Could you get them to come in more often?
4. What are you doing to make sure your customers don't leave you for the competition?
If you are trying to run a business, it may seem like a whole lot of work to run the numbers and try to answer those questions. But like the gentleman of my acquaintance who bumped up his raise, the extra work could pay off for years to come.
You can read Phil's entire newsletter HERE - and sign up to receive it yourself, if you like.
