What is your business’s most valuable hidden asset? If you are like most business people, your mind might quickly scan over your balance sheet to get the answer. Is it your equipment? Is it your location? Is it your accounts receivable? For most businesses, the most valuable business asset isn’t on the balance sheet. It’s their customer list. Those businesses for which this isn’t the most valuable business asset should change their perspective to make it so.
The hardest, most expensive sale that we ever make to a customer is the first one. In that first, critical, transaction we earn or lose the trust of the customer. Once we have the trust of the customer, we open the door to many more sales and to referrals, which most of us agree are the very best new customers to get. Many businesses frantically work at bringing in new businesses while they neglect developing the wealth of information that they already have represented by their customer list.
Why would you want to know the lifetime value of a customer? The lifetime value of a customer is a measure of the value of the customer to your business. It is the potential contribution of the customer to your business over a period of time.
When you know the lifetime value of a customer, you have a benchmark for how much you would or should be willing to invest to acquire a customer. When you evaluate the effectiveness of your marketing, instead of focusing on the response ratio (how many responded compared to messages delivered), you should focus on the return received (number of customers times lifetime value) for the investment made (campaign cost). When you know this, you find you can justify a much greater promotion investment when you look at your returns in this way. This provides the engine for significant business growth. Your competitors may not want to make the necessary investment, so this can give you a competitive advantage.
How can you quantify the “lifetime value of a customer”? Estimate the profit for the transactions you expect to have with the customer over the period you expect to do business with him or her. If this is an unknown long term, use five years. You should collect statistics of the transactions done with customers and how long you keep customers. Also, factor in the benefit for referrals from your customers.
Here’s an example: At a computer software store, customers make average purchases each year of $500. The average gross profit is 30%. Most customers do business with the store for five years. One out of three customers refer a new customer.
Average purchase: $ 500
Total Purchases: $500 x 5 = $2,500
Gross profit %: $2,500 X .30 = $750
Add 1/3 gross profit for referrals: $250
Total Lifetime Value of A Customer: $1,000
If this business invested $1,000 to get a new customer, it would “break even.” Obviously the business wants to make a profit, but now it has a benchmark to work on based on its own situation.
Also, advertising and promotion now represent an investment on which a return can be measured, instead of just an expense “thrown against the wall.” Try applying this lifetime value approach in your business as a growth strategy.
If you have questions or need help in calculating the lifetime value of your clients, contact us today.
As a CPA, Accredited Small Business Consultant and Advanced Certified QuickBooks ProAdvisor, we mentor small business owners to empower them with the tax, accounting, and financial knowledge and business skills to run a successful business. Allow us to evaluate your small business needs. Give us a call today at (727) 391-7373 or visit us at http://www.LStortzCPA.com and www.tampabayaccountingservices.com.