Title: Don’t Be Afraid of the Numbers: Customer Lifetime Value
Guest: Emily Caddell
Peter: Quick question. Do you know how much money your customers bring into your business over the course of your relationship with them? If not, or if you’re not sure, stick around.
Emily: Awesome. Well, welcome to, don’t be afraid of the numbers. Our miniseries that breaks down one vital marketing metric each episode so you can make data-driven decisions without the dread.
In our second episode, we’re looking at the other side of the CAC coin, customer lifetime value, or LTV. Peter, take it away. Thanks.
Peter: Yeah. Customer acquisition costs, or CAC as we called it, is calculating by taking all of your marketing and advertising spend for a given period and dividing it by the number of new customers you acquired in that period.
So in our example, if you spent $8,000 on marketing last month and you brought in 40 new customers, your customer acquisition cost is $200. So that helps those numbers. [00:01:00] The cac, it helps you understand how efficient your marketing and sales efforts are. Obviously, a lower CAC means you’re bringing in customers more cost effectively, and your advertising and sales efforts are more efficient.
And if it’s going up, if your customer acquisition cost is going up, could mean a number of things, but it means that you should possibly look at optimizing your campaigns. Your sales follow up, and it could be a sign that you are experiencing competition in your marketplace. So knowing your CAC is kind of the first step to understanding your marketing metrics.
If you want to check out that episode, it’s the last episode in this series, and we’ve got all the information there, including a worksheet that you can download. Today we’re gonna talk about how much value. Those customers bring back to your business. Customer lifetime value or LTV or [00:02:00] CLTV captures the long-term value of a customer for your business.
It tells you how much money a customer’s likely to generate for your business over the entire customer life cycle, not just their first purchase. So it’s the number that tells you whether your business is built for growth or headed for burnout. We call it the value of keeping a customer. Because if CAC is the cost of winning a new customer, LTV is the value of keeping one.
Emily: Why does lifetime value matter?
Peter: Good question. So now there’s one big assumption that we’re making here. With respect to lifetime value, we’re assuming that you’re not just selling a single one-off product. One and done. Mm-hmm. Lifetime value. Is very easy to calculate if you’re just selling a single product one time to each customer, right?
Mm-hmm. Most of the businesses we work with are services businesses, and they have repeat customers, repeat business, or a recurring [00:03:00] business model where they are charging a customer over time. Now, if you’re just selling them a roof. Then that’s generally speaking, whatever your average price is for a roof, that would be your lifetime value.
It’s just whatever that is. Yeah, times one. Knowing lifetime value helps you understand how much you can afford to spend on acquiring new customers. This relates to the CAC formula because if your CAC or your customer acquisition cost is $200. The lifetime value of a customer is $2,000. That’s the amount that you’re gonna earn over the lifetime of that customer.
Then you’re in good shape. But if your customer acquisition cost is $500 and your lifetime value is $400, you’re losing money with every new customer. And your marketing is not sustainable. Your business is not sustainable either. Alright, let’s look at how to calculate. [00:04:00] LTV and kinda the three things that go into the equation.
The first thing that goes into this equation to calculate your customer lifetime value is your average revenue per sale. Now we’re using average revenue. Some people think you should use gross margin. Mm-hmm. Per sale. That’s a little more involved to come up with that number. So just for sake of.
Argument today, we’re going to use revenue per sale. So your average revenue per sale is one element in here. The purchase frequency, meaning how often do your customers purchase from you, for example, in a year. And then the last thing is what we call lifespan. How long is that customer going to be purchasing from you?
Now, one thing to bear in mind is that we’re talking about. Businesses generally that are selling to customers more than one time. We’re [00:05:00] talking about either recurring or reoccurring type business model here. If it’s a one and done type sale mm-hmm. Then that obviously is, you know, this is much easier to calculate because you don’t have that purchase frequency piece.
You may get some repeat customers, but it’s. Probably few and far between. So this is really easy to calculate in that case. Mm-hmm. So let’s go ahead and look at an example here. So let’s start with average revenue per sale. So how do we figure this out? So what you do is you take the total revenue over a period of time.
So let’s say we’ll take it over a year, and in our example, this business sold a hundred thousand dollars in a year. They’re just getting started, right? Then you want to figure out how many purchases there were during that period. Not customers but purchases. So in this example, there were 250 purchases.[00:06:00]
The average revenue per sale is $400. So that’s step one is this average revenue per sale. Now the next thing is purchase frequency. So again, this is how often. Customers purchase over the course of a year. So the way to calculate this is you take a period of a year and you figure out how many purchases there were, and then divide that by the number of customers.
So in this particular case, they had 250 purchases or transactions. They had 125 customers, you divide two 50 by 1 25 and you get two. Mm-hmm. So that means the average customer purchases two times a year. So that’s your purchase frequency and average [00:07:00] revenue per sale. Now we’re gonna look at the customer lifespan.
Now if you have good data, you can use that to figure out your customer lifespan. Otherwise you’re gonna have to estimate it using customer behavior. We’ll talk about that in a second. So what you’re gonna do is you’re gonna look at your customer list, your total customer list. Mm-hmm. So for our example, let’s say you have total of 500 customers on your list.
And then what you want to do is if you look at the first purchase. You take the amount of time from the first purchase to now, assuming that they’ve continued to purchase from you over time, right? Let’s say you have some people that may have bought from you 10 years ago and they’re still your customer.
That’s like us. We’ve got people that have been customers for 10, 12 years. You total up the number of years associated with each customer, and then you total up all of that. So our, an [00:08:00] example, we’ve got 500 customers. In the total active years equals 2000. So there’s 2000 total years from those 500 customers that are with us today.
So the average lifespan of these customers is 2000 divided by 500. ’cause there’s 500 customers. Equals four years. So that is the final component that you’re gonna need to figure out your customer lifetime value. Now, if you don’t have the numbers available to you, let’s say you switched accounting systems and stuff like that, what you’re gonna have to do is you’re gonna just have to estimate the behavior.
So just look at how often they returned and talk to your long-term customer, see how long they’ve been your customer. [00:09:00] The other thing you can do is look in your CRM or your billing system potentially to figure out when did you first start working with that customer? And then just go to today,
Emily: what can someone learn from knowing their customer lifetime value?
Peter: Yeah. So you can really gain clarity on how much you can budget for your marketing and advertising by having a number that you can compare to your customer acquisition costs. You have a sense of what a new customer is worth. Mm-hmm. And how much you can afford to spend to get one more customer.
Basically, first and foremost, the value of the customer and how much you can afford to spend on getting those new customers. You can also learn when you should be running what we call retention campaigns. So if your lifetime value is decreasing. You have a product that does have repeat purchases like we talked about, then you should consider running what we call [00:10:00] customer retention campaigns and WIM back campaigns.
So you may have a customer list, like let’s say you’ve got 500 people on your customer list, and instead of purchasing twice a year, they’re purchasing on average 1.5 times a year. Something is leading them to not come back. It’s a good thing to do to get out there with something called a win back campaign, where you are just reminding customers of the value you provide, reminding them of the benefits of your services, and if they have a real need, you know, maybe you have a special offer as well for them.
So the other thing you can do is if you segment. Your business. Let’s say you have multiple products and you have multiple types of customers you would want to actually try to segment your customers, and one of the things you can do is you can look at the customer lifetime value and start to determine what segments of customers are worth spending a lot of [00:11:00] time getting more of.
And you may discover that there’s a class of customer that’s either spending a lot less money or a lot less frequently, or they’re not sticking around. And if you can identify the characteristics of those customers, you can segment them and prioritize those that have a higher purchase amount, higher frequency, and stick around longer.
Emily: I would love just to hear maybe some examples of how a business could increase their lifetime value of their clients.
Peter: Yeah, so you know, a lot of businesses think about increasing their revenue per sale, which is great, you know, we should all do that. But many neglect purchase frequency. One of the things that could happen is I found in our business, like we have revenue per sale for one of the products that we offer is relatively low.
But it’s purchased every month, and the [00:12:00] average customer lifespan for that product is measured in practically decades now. Yeah, so the LTV from that one product is insanely high. A lot of businesses think about that revenue per sale, but don’t neglect. Purchase frequency where you are encouraging customers to purchase more often if you have an HVAC company.
One thing that they can do to supplement their lifetime value of their customers is to have packages where they’re offering a spring AC tuneup, and a fall furnace tuneup. Turn that into a package that includes filter replacements, and sell that as a service. So they’re going from being a one and done type company to being more of a ongoing maintenance company for the bus, for the home, and.
When it does come time for the AC unit to be replaced or the the furnace to be replaced, they’re the obvious choice to do that, and they’ll be right there inspecting the [00:13:00] equipment and they’ll know when it’s time to upgrade. Yeah. Another one would be an auto repair shop. They might offer like a loyalty discount and encourage customers to get their vehicles prepared for each new season.
Like, you know, summer travel season, winter weather. So, yeah, some loyalty discount. You know, maybe they offer a free oil change once a year. Healthcare provider could offer a wellness program that encourages regular patient checkups. If you’re dealing with health and wellness, some things are symptomatic that you need to have check, but other things are just more like a wellness oriented thing.
If you get on a regular schedule of getting checkups and maintaining. The numbers in your health, that can help a lot. Another one kind of related is veterinarian may offer package that includes annual wellness checkups for dogs and cats. Mm-hmm. Last one that I thought of was like a pest control company.
You know, you don’t just call them when you’re needed. The best way to work with a pest control [00:14:00] company and best for them too, is like a monthly or bimonthly service. Like we have a bimonthly service with one of our clients that comes and spray the perimeter of our house. So maybe before we
Emily: sign off, I would like to hear a couple questions that business owners should be asking themselves.
About their lifetime value and maybe how it also relates to their customer acquisition costs as well.
Peter: Yeah. Again, this goes back to the similar way that we presented this in the CAC episode, which is, do you know your current customer lifetime value? Have you sat down and done that calculation? Have you sat down with your bookkeeper, your accountant, or your office manager or somebody in your organization to figure out your customer lifetime value?
Second one. How does it compare to your customer acquisition cost? Is your lifetime value much greater than your customer acquisition cost? I hope it is. But if it’s closer than you’d like, what do you need to do to fix that? [00:15:00] What products or services in your business are creating the highest? Lifetime value, either from a purchase, price, frequency, or retention.
There’s three factors that go into that. Maybe you’ve got something that people just keep coming back for year after year, and it could be something that’s a real kind of a hidden profit generator for you. So look out for those things in your business. Couple other things. How can you increase customer loyalty and repeat business in your business?
And last one we kind of touched on this. Are you tracking lifetime value by customer segment, either by what product they’re purchasing, or even some other attributes like are they from a certain neighborhood or you know, other attributes that you may identify you don’t have to use just by product, for example.
Mm-hmm. Yeah. So I mean, lifetime value really helps you zoom out. And figure out what’s happening. And the [00:16:00] thing is, CAC is what you spend to get a new customer. Lifetime value is what you earn back. So track both, and you’ll know whether your business engine is built for sustainable profit or pain.
Emily: Thanks, Peter, and thank you all for listening to Don’t Be Afraid of the Numbers.
In our next episode, we’re gonna connect the dots between cac, LTB and Profitability, so don’t miss it. Subscribe to The Field Guide Podcast by Biz Marketing wherever you get your podcasts, and we’ll see you next time. Thanks.
