HOW MUCH IS A CUSTOMER REALLY WORTH?

Successful businesses know the true worth of a customer …. and I don't just mean that they recognise that customers pay their salaries. Understanding how much value a customer really adds to your business is critical to many decisions that impact on your marketing and operations.

So What Is The True Value Of A Customer?

Many businesses assess a customer's worth based on the value of the customer's first purchase instead of the customer's lifetime value.

To illustrate the point, let's run through a simple example:

1. A new customer purchases $100 worth of product from your store. After taking into account the cost of the product, sales commissions, etc let's say that leaves you with $50 profit on the sale
2. Now let's assume that the customer was happy with your products and service and so spends $100 with you, on average, every 3 months. That's $400 in sales and $200 in profit in the first year
3. The customer then typically remains loyal to you for another 3 years (before moving out of the area). So far you have received $1,200 in sales and $600 profit from this customer
4. During the 3 years, this “happy customer” has told 4 other people each year about their experience and 25% of them then become customers. That's 3 more new customers. Even if they don't refer anyone at all to your store, you will have received $4,800 in sales and $2,400 in profit – all because of that original customer spent $100 on their first purchase in your store

In this example, you can see the enormous difference in value - $50 profit based on the first sale vs $2,400 profit when viewed over the customer's “lifetime” with you.

You can do the sums for the average customer for your business and, even if it is not as dramatic as in this example, you will see that the true value of a customer is much more than the value of their first purchase.

The Implications Of Knowing A Customer's Lifetime Value

For starters, you can now place a more objective value on product quality and customer service.

If the customer in the above example had received poor customer service and never made that original purchase, the business would have missed out on the opportunity of at least $2,400 in profit …. and remember that bad publicity usually spreads much wider (and quicker) than good news so the potential loss would be even greater.

Your average customer's lifetime value also has a significant bearing on how much you can really afford to spend on attracting new customers.

Using the above example again, if you knew it was going to cost you $50 in marketing to get this customer to purchase from you, would you have done this?

If you were comparing the marketing cost with the expected profit from the first sale, you would not have proceeded. However, a $50 marketing expenditure for an expected profit of $2,400 sounds far more viable.

NB Don't forget that you do still need to pay for your other overheads, so you most likely won't have the cash flow to just break-even on all “first time” sales. However, this example does show the long term value that can be gained for the business from investing in growth.

Finally, by understanding the customer lifetime value equation for your business and monitoring the changes in it, you can also more readily see what areas in your sales and marketing process need more attention …. and this topic will be covered in more depth in future issues.