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The Impact of Understanding Customer Acquisition Costs and Customer Lifetime Value

The Impact of Understanding Customer Acquisition Costs and Customer Lifetime Value

It’s guest post day here at Duct Tape Marketing, and today’s post is from Dan Kraus – Enjoy!

Have you heard someone talk about customer acquisition cost (CAC) or customer lifetime value (CLV or LTV)? If you’re in the tech business, and especially if you work with SaaS products, you’ve definitely heard of, and can likely calculate, these values. If you’re not in the tech industry, you should learn about these numbers, as they have enormous value for businesses of every type and size.

CAC is how much you spend to acquire a customer. In the simplest of calculations, it’s the amount you spend on sales and marketing divided by the number of customers you get during the period you’re measuring.

CLV is the net value of a customer to the company–how much money a customer spends during their entire relationship with you, minus the costs of products and services they buy.

Used together, these numbers help drive your overall business strategy, including your marketing approach.

Here’s a simple example. I met with a plumbing services business that cleans out drains as their primary business. We talked about their starter offer (how they get new clients in the door), which focused heavily on emergency clog removal through their 24-hour hotline.

They historically charged $149 for an emergency cleanout. Their loaded cost to do this, including technician time, vehicle wear and tear, and materials, was about $70. They wanted to clear a net profit of 20% ($30). Backing the cost and profit allocation out, we had $49 left to cover marketing and non-allocated overhead. After talking, we determined we needed to acquire a job/customer for $35 if the emergency clog removal was all they sold–a very challenging number to achieve in a market as big and competitive as Charlotte.

So we talked about the lifetime value of a customer. Less than 10% of the customers they worked with bought any other services–on the first service call or in the future–and their additional purchases were around $200. After taking out costs, we determined that their average CLV was approximately $42. They quickly understood that they needed new business strategies if they were going to grow.

They needed to increase the lifetime value of a customer. If they did, they could afford to spend more to acquire new customers. This realization drove them back to business planning because they needed to make decisions about customer service, cross-sell and up-sell plans, marketing to previous customers, and even compensation plans for their techs.

No matter what business you’re in, you can figure out your CAC and CLV and use the numbers to support or change your strategies and tactics. If you’re in professional services, use the numbers to understand if you need to focus on getting more repeat business or acquiring new customers. If you sell products in a brick-and-mortar store, the numbers will help you plan your promotional budget and adjust your product mix. If you’re a local services business–plumbing, car repair, landscaping, etc.–you can use your CAC and CLV values to determine how much you should spend on marketing to new customers versus providing better service to current clients.

John makes the point in this blog post that CLV is unlimited if you have delighted customers because they refer you, and those referrals have no CAC. If those referrals then refer you again, you end up in a virtuous cycle. I couldn’t agree more, but you have to start that cycle somewhere, and that somewhere is understanding where you are now so you can be smarter about where you invest going forward.

So, break out the spreadsheet and get some help from your bookkeeper, accountant, or financial advisor to figure out a basic cost of customer acquisition and customer lifetime value.

Those numbers will help you answer critical questions like:

  • How much should I budget for marketing based on the goals I have for gaining new customers this period?
  • How much should I be investing in customer delight, customer experience, and customer support?
  • Where should I focus my sales team and how should I structure their compensation plans for the results I want?
  • Which products or services should I concentrate on to get the customers I want to work with, and who are also profitable for our company?

Want to learn more? Try these other resources:

The Cost of Customer Acquisition: How Much Can You Spend to Earn New Business?

The Ultimate Guide to Calculating, Understanding, and Improving CAC in 2018

How to Calculate Customer Lifetime Value

Dan Kraus

Dan Kraus is the founder and president of Leading Results, a marketing consulting agency based in Concord, North Carolina. Through his firm, Kraus helps business owners develop a marketing strategy that empowers them to be self-sufficient and ensures their long-term success. Find him on TwitterLinkedIn, or on his blog.

customer lifetime value

What Exactly Is Customer Lifetime Value and Why Should You Care?

In the marketing world, niche terms and metrics get thrown around frequently, and while there is some jargon that you can just shrug off, there are others that you should pay attention to, which brings me to the topic I’d like to discuss today: Customer Lifetime Value (CLV).

This is a metric that is often misunderstood and, even more often, overlooked completely. In a nutshell, Customer Lifetime Value is the calculation of what a customer might be worth to your business over the course of doing business with you, perhaps over the course of a few years as opposed to a single transaction.

This number might change the way you look at how much you are willing to invest to get each new customer, so as you can see, it’s an important number to follow. Once you understand the lifetime value of a customer, you can determine how much you’re willing to pay in new customer acquisition costs.

For example, if a customer buys a $500 service once every year on average for ten years if you keep them happy you might determine you can invest more in landing and thrilling that customer.

This change in point of view often leads business owners from viewing marketing as an expense to viewing it like the investment it can be. Of course, there are many factors that impact CLV over and above simply measuring it.

Who should care about Customer Lifetime Value

For businesses that offer a customer multiple transactions over time, the concept of Customer Lifetime Value is pretty significant. For businesses such as home builders, who might only work with a customer once in their lifetime, this concept might not seem to matter. Seem being the keyword in that sentence.

In my opinion, the lifetime value of every customer, including those who make a one-time purchase, is unlimited because of the potential for referrals they can make. A happy, single-transaction customer might be a source of business for years because they are likely to talk about your business and recommend you to others. It’s happened to me personally numerous times.

How to calculate Customer Lifetime Value

To get technical:

LTV = Revenue from each paying customer per month, multiplied by Gross Margin, divided by churn (Gross Margin is the amount left over after the cost of goods sold, churn is the percent of people who leave).

Let’s break that down a bit.

  1. Computer your average sale and gross margin of profit – we’ll call this number M (margin)
  2. Determine the average number of sales, transactions, renewals, etc you can expect over some period if you keep your customers happy – we’ll call this number R (repeat, renew)

In simplest terms CLV = M X R

I have a $2,000 product, and on average I make about $500 off of every transaction, and people buy on average 4.75 times over the course of the relationship – it could be said that my CLV = $2,375 or $500 X 4.75

Now, with that number in mind I can make some decisions:

  1. Am I investing enough if acquiring more customers?
  2. Could I find more products and services to sell?
  3. Could I find ways to create more frequent transactions?
  4. Could I find ways to get more referrals from these happy customers?
  5. Should I adjust my current pricing based on generating more sales or more profit?

A few notes for calculations purposes:

  • Try to establish your baseline CLV # (where it stands today), so you have something to go to work on.
  • The R # in the equation is a huge variable and can include transactions, renewals, upsells, new products, special offers, etc. It’s the number you can impact the easiest with your marketing efforts.
  • If you have happy customers, there’s a very good chance 20-25% of them would like to buy more – substantially more – go to work on that and make it a strategic initiative as soon as possible.

Here are some more suggestions on how to think about the relationship between CLV and Customer acquisition cost, as recommended by Jay Abraham, author of Getting Everything You Can Out of All You’ve Got:

  1. Compute your average sale and your profit per sale
  2. Compute how much additional profit a client is worth to you by determining how many times he or she comes back
  3. Compute precisely what a client costs by dividing the marketing budget by the number of clients it produces
  4. Compute the cost of a prospect the same way
  5. Compute how many sales you get for so many prospects (the percentage of prospects who become clients)
  6. Compute the marginal net worth of a client by subtracting the cost to produce (or convert) the client from the profit you expect to earn from the client over the lifetime of his or her patronage

Regardless of how long the average lifetime of your customers is, Customer Lifetime Value helps you determine how much you can spend for acquiring a new customer as well as how much you can spend to keep your current customers.

How to increase Customer Lifetime Value

Here’s why I love this metric – a focus on this North Star kind of number gives you lots of room to look at every aspect of your business because many times this number can increase by simply creating a better customer experience.

To improve your company’s Customer Lifetime Value across the board, you need to take care of your customers and ensure that they are loyal to you. A few ideas to do this include:

  • Improve customer service – provide your customers with the ultimate customer experience. This will help them to become repeat and loyal customers and will increase your odds of referrals.
  • Solve your customer’s problems – remember, customers care about their interests, not yours. Make all marketing efforts and outreach client-centric and address their needs and pain points.
  • Show you know your customers by sending them something they didn’t even know they wanted – this personalization shows that you care and helps to build trust and relationships with your audience.
  • Listen to what your customers have to say and keep them informed when a change is made based off of their feedback
  • Provide value even when it’s outside of your wheelhouse (this is why I’m very vocal with the idea of creating a strategic partner network)
  • Reward loyalty – Make them know how much you appreciate them being brand advocates. You should appreciate all that loyal customers do for you, and it’s important that you show that.
  • Feature customers in your content or give them shout outs – make them feel special

Essentially, your marketing campaigns should nurture current customers as leads. If your lead nurturing endeavors are successful, then your average LTV should increase. If it isn’t, then you know that you need to make adjustments in your lead nurturing endeavors.

The higher your Customer Lifetime Value is, the better off you are regarding acquisition costs. The high value means customers stick around and maintain a relationship with you, which can lead to consistent referrals moving forward.

Hopefully, based on the information I’ve provided above, you’ve realized that this is a metric that can’t be ignored for all businesses, but especially for small business that need to pay attention to their bottom line.

So, let me ask you, are you tracking Customer Lifetime Value? If not, it’s time you start.