Better Business Idea #13

The Lifetime Value of a Customer

May 29, 1998


Quick! What is your most valuable business asset?

If you are like most business people, your mind might quickly fly over your balance sheet. 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. And those businesses for whom this isn't the most valuable business asset should change their orientation to make it so.

The hardest, most expensive sale 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 "acre of diamonds" at their doorstep 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). Suddenly you find you can justify a much greater promotion investment when you look at your returns in this way, and this provides the engine for significant business growth. Chances are your competitors are too cheap to make the necessary investment, and 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.

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