Calculating the Lifetime Value of a Customer
When I lecture about direct marketing, I often ask the question, “who knows how much you can afford to spend to get a new customer?” I am amazed that most of the people in the audience have no idea. Yet, to conduct a direct mail program or, for that matter, any advertising program, you really need to know. If you don’t, it will be very difficult to determine how much you can afford to spend.
What do we mean by “lifetime value of a customer”? Lifetime Value is simply the value of all of the business we expect to do with a customer during the lifetime of our business relationship.
As an example, a well known grocery store operator, Stew Leonard, once made such a calculation. He determined that his average customer visited his supermarket once a week and spent about $100 on groceries. He also determined that his average customer remained a customer for about ten years. So, taking this information we calculate Lifetime Value as follows:
- 52 weeks @ $100 per week = $5200 per year
- $5200 per year x 10 years = $52,000
So, for Stew Leonard, the lifetime value of every customer is $52,000. With that information Mr. Leonard can now determine how much he can afford to spend to get a new customer. I’m sure that a cost of $5 or $10, and probably much more, would not deter him a bit.
How can you go about figuring this out for your own business? Much the same way we did in the example above. How many customers does your business have? How much do they spend with you every time they come into your business location? How many years do they stay with you? With this kind of information at hand, you can begin to develop some useful statistics and can make meaningful investments in advertising.
Lifetime Value also teaches us that we don’t necessarily need to make a profit on our first transaction with a customer if we know that we are likely to make more money on future purchases made over a period of time. It is this concept that guides mail-order book and CD clubs when they make such offers as 4 CDs for $1 each when you agree to buy only 4 more at full price. They lose money on that first offer, but they gain a new customer that experience has shown them will render a profit over a longer-term relationship.
So take the long term look at your business. How much would it be worth to get 100 or 200 new customers and, knowing that, how much would you be willing to spend to attract them to your business. Taking this long term approach, you should be able to do many more things with your direct mail or other advertising when you don’t have to make a profit on the first transaction.