What is customer lifetime value?
Customer lifetime value refers to the total amount of ongoing, cumulative profit that a type of client (whether a patient, buyer, customer or source) is worth. We know that not all buyers are the same; they have different needs, come from different sources and have different rates of repeat purchasing. No matter where a client comes from, they are worth a certain amount to your business profit for both the initial sale and their subsequent purchases.
When you understand your customer lifetime value, calculations about how much you can afford to invest in acquiring new clients are much less mysterious. To put it another way, two of Jay Abraham’s first questions for new clients are “What is the lifetime value of your customer?” and “What do you spend on advertising and promotion?” Often businesses don’t know their customer’s lifetime value, which means they have no idea if their current spend (or allowable cost) on promotion and lead generation is a worthwhile investment.
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Make your customer lifetime value calculation
There are many formulas for calculating customer lifetime value out there. Instead of getting into mathematical equations, let’s just look at the elements that comprise lifetime value (i.e., the net bottom line profit or what a new customer is worth to you):
- Profit available on the initial purchase
- How many times new buyers will most likely repurchase that product over the next year
- Number of years buyers will continue to purchase
- Additional products or services buyers will most likely purchase (These can be in addition to, or instead of, the main product over the course of the typical buying cycle.)
- Profit on these subsequent transactions
Look at average unit of sales and the corresponding profit as well as client buying habits. How many new clients come back, with no effort on your part, in month one or month two? What about per year? Keeping data about your marketing strategy will let you see what performs best in terms of getting new clients vs return purchasers. When you go to calculate customer lifetime value, make sure to calculate for worst case scenarios, not the best. Not only does this allow for more windfall profits but it also ensures you won’t overspend on client acquisitions.
3 Impacts of knowing your customer lifetime value
1. Improve your sales strategy
Once you calculate how much the average client will be worth for your business, you can better improve your sales strategies. For example, Jay worked with a business that was running out of money and didn’t know how to improve their sales. Jay asked the company how much each new customer was worth; how much would they buy in a year and how long did they tend to stay active clients. They found that the average initial sale to a client made $200 in gross profit to the company and that, on average, a client would buy five times a year for three years, adding up to an average lifetime value of $3000 profit for each new customer. Members of their small sales team would earn 10% of the profit from their clients, so for their initial average sale of $200, they made $20 and the company made $180.
Jay’s solution was simple: set up a new basis for sales commissions. If sales team members kept their existing customers at or above what they had averaged in the past, they would get 100% of the profit for every new sale they accrued. That means that instead of making $20 on a new client, the salesperson would make $200. That gave them ten times the motivation to bring in new clients than before, each creating an average of $3000 profit for the company because of the customer lifetime value. The company said it would never work, but agreed to try. Sales tripled. Not a bad outcome for a such small shift.
2. Create leverage for smart joint ventures
Knowing lifetime value also makes setting up profitable joint ventures more advantageous for both parties. You can give away what will be a fraction of your customer lifetime value and still come out on top. Let’s look at another example: say you run a bottled-water delivery service. Your residential customers spend about, on average, $50 a month every month for at least three years. At $50 for 36 months, that makes for a customer spend of $1,800 and, if your net profit rate is 40%, a customer lifetime value of $720.
With these numbers guiding you, lead generation can really take off. You can go to media outlets (radio, TV, newspapers, etc.) and make a deal: instead of paying for advertising, they’ll make $25 of every new sale generated by running your ad. You could even, if you have enough cash flow, offer them all $50 of the first sale. They’re likely to make more money than you’d spend paying their advertisement rates and you’ll have an incredible return on investment (ROI) for the next three years. Jay’s made media deals like this where he gave 100%, even 200% of the first sale and, through understanding the amount of a customer’s lifetime value, ended up with incredible profits.
3. Keep your clients deliriously happy
How much are you willing and able to spend to keep your clients happy? The answer changes dramatically if their lifetime value is $300, $3,000 or $30,000. Knowing how much you can invest in your client – both to make the initial sale and to encourage repeat buying – allows you to keep your clients surprised and delighted, making them loyal for life. Offering special discounts or other exclusive benefits often results in better than average purchasing, driving your net profits even higher.
Joint ventures are also an excellent way to combine forces with another business to help benefit both business’s clients, especially if you’re able to offer incredible value. Say there’s a local gym that gives certain retailers trial membership certificates good for six months of training sessions and equipment access, a $500 value. The retailers offer a membership certificate as a bonus for all purchases over $200. We know that we’d be interested in getting not only products or services we wanted but almost double that in value for free, wouldn’t you?
So if one of every four people who come and use their membership certificates becomes a full member with a lifetime value of at least $3,000, everyone wins. The clients get more from their purchase, the gym owner has conversion rate of 25% with minimal outlay and the partner retailers add more value for their clients, likely resulting in higher repeat purchases and customer loyalty. Know how much you can spend on your clients – giving away a $500 value to make a $3,000 profit is sensible, but not so much if the gym owner only made $100 profit – and your sales will explode.
Jay Abraham is a proven business leader and top executive coach in the United States, and a close friend of Tony Robbins. Jay has spent his entire career solving complex problems and fixing underperforming businesses. He has significantly increased the bottom lines of over 10,000 clients in more than 1,000 industries, and over 7,200 sub industries, worldwide. Jay has dealt with virtually every type of business scenario and issue. He has studied, and solved, almost every type of business question, challenge and opportunity. His principles can be the difference between mediocrity and a business that generates millions of dollars in additional revenue.
What does Tony have to learn from Jay?
Listen in on Tony’s conversation with Jay to hear everything from how to “ask the right questions” to how to stand out in a crowded market.