Summing up business
Purloined goods found in market
Existing customers are the real assets of any sales-oriented organisation. Knowing their lifetime value is key to helping you make decisions on how much you can afford to spend on recruiting new customers and, perhaps more importantly, on how best to increase the earnings you achieve from each of these existing customers.
Lifetime Value
The lifetime value of a customer is the amount they will contribute to the bottom line of a business over the span of its relationship with them. But before this can be calculated you should consider the following:
(a) What is the value of an average sale? For this exercise, divide your total sales revenue by the total number of sales in a typical year. For the example below, a nominal value of £100 is used.
(b) What is your percentage profit margin? The example below assumes a 20% margin.
(c) What is your typical customer's purchase frequency? This can be calculated by dividing your total number of sales by the total number of customers in a typical year. For the example below, a frequency of three times a year is used.
(d) What is your typical customer's lifespan? How long does your typical customer continue to do business with you? If you are not sure, then be conservative, estimating two or three years. The example uses three years.
(e) How many referrals does your typical customer give you in a year? If your customers are happy with the service they get from you, then they will often bring you referrals and most will be pleased to give you referrals if you ask.
If you do ask, it would not be unreasonable to expect five referrals a year from an existing client. This is the figure used in the example below.
(f) What is your referrals hit rate? How many of these become customers? Given that these leads are pursued on the basis of a known recommender, the example uses a hit rate of 40%.
Calculating Lifetime Value
Armed with this information, you can now calculate your typical client's lifetime value. To illustrate the relative impact of the various factors used in calculating this figure, it is calculated below in four separate steps:
Annual profit from a typical customer: (a) 5 (b) 5 (c) = (g). In the example: £100 5 0.2 5 3 = £60.
Lifetime profit: (g) 5 (d) = (h). In the example: £60 5 3 = £180.
Referrals value: (e) 5 (f) 5 (h) = (i). Successful referrals become customers, so in the example the referrals value is: 5 5 0.4 5 £180 = £360.
Lifetime value: (h) + (i). In the example: £180 + £360 = £540.
What use is this figure?
The lifetime value figure illustrates how important it is to make an effort to retain and develop existing clients. Achieving the same margin through one-hit deals would take 27 new sales.
What it also illustrates is how important it is to seek referrals from existing satisfied clients. In the example worked above, the lifetime value of the client was increased by 300%, simply on the basis of referrals that led to new clients.
Additionally, your typical client's lifetime value allows you to calculate exactly how much you can afford to spend on winning new clients.
And the figure also highlights how you could dramatically improve the performance of your organisation simply by making small efforts to change any of the key figures used to derive it.
For example, suppose you made the following modest changes to the example: increase the average sale value by 10%; improve the margin by 5% by focusing more on existing accounts where the cost of a sale is lower; increase by one the number of sales per year by staying closer to your customers; stretch the lifespan of the customers to five years by looking after them better; increase the number of referrals by, say, 40%.
Calculate it yourself, these modest changes would: increase the annual profit from the typical customer to £110, an increase of almost 55%; increase the profit earned from a typical customer in their lifetime by more than 300% to £550; raise the value of referrals increases to £1,540; increase the lifetime value of your typical client to £2,090.
This 387% increase in the lifetime value of the typical customer resulted from the cumulative effect of relatively small, and eminently achievable improvements in performance and service.
