Every business owner is familiar with these three concepts:
- Retaining existing customers is cheaper than acquiring new ones.
- Eighty percent of your business comes from 20 percent of your customer base.
- The best new business is referral business.
It’s clear that keeping customers and developing customer loyalty brings remarkable value to a company. Certainly, it is one of the primary reasons behind any firm’s success. And most all owners and employees know customers are one of your most valuable assets. But just how valuable are your customers? According to a 1994 Harvard Business Review study, Putting the Service-Profit Chain to Work, found “an increase of 5% in customer loyalty can increase profitability by 25-80%.”
While this statistic emphasizes the importance of customer loyalty, it is even more helpful to understand exactly how much a customer is worth to you now. This is also called the “Lifetime Value of a Customer.” There are numerous ways to calculate the lifetime value of a customer to a company. No matter the measure, producing a concrete dollar figure gives you a tangible point around which to design customer retention strategies, promotional campaigns, and even bonus plans. (Note: The following calculation does not determine profit, rather the overall customer value.)
Here’s a quick way to determine the lifetime value of your customers. The box to the right corresponds with explanation below.
- What is your average sale or average amount of money a customer spends per month? (Simply add up your total dollar sales for a year and divide that by the total number of sales transactions you completed.)
- How many times a year does an average customer buy from you? (Take your total number of sales transactions for a year and divide it by the total number of customers.)
- What is the expected number of years a customer will use your services or buy your products?
- How many people per year does your average customer tell about your company? (You may have to guess at this one. It’s probably between 3 and 12. Generally, the better your customer service, the higher this number will be.)
- What percentage of these people actually become customers? (Usually between 20% and 70%.)
Let’s apply this calculation to a local personal coaching business. If each coaching session is $150 and the average customer has two sessions a month, the gross sales per customer is $3,600 per year. Estimating that a customer stays with their person coach on average for five years, the lifetime value of this customer, before referrals, is $18,000. Customers that are seeing results from personal coaching will more than likely tell their friends. The power of positive word of mouth magnifies the value of each customer. If we conservatively estimate that each customer tells four people and 50%, or two, become customers, the gross sales from referrals is $36,000. Therefore, the total lifetime value of a customer is $54,000 (the gross sales per customer plus gross sales from referrals)!
Now, do the exercise in the box. Find out for yourself just how much money each of your customers is worth to you.
The outcome of this calculation represents a relatively accurate estimation of your customer’s value to your company over the course of the customer’s lifetime. No wonder it is so important for employees to understand the value of each customer! Clearly, customer retention should be among any firm’s most important priorities. But success doesn’t occur in a vacuum. Rather, strong customer retention rates result from customer satisfaction. This, in turn, results from the firm’s continuous ability to provide value at all contact points with the customer. When you have satisfied customers, you will also have a strong referral base. The impact of positive word mouth has a multiplying effect in this calculation and also in the marketplace. When designing long-term strategies or assessing the cost of losing customers, this equation can provide a sobering illustration of the results of your efforts. Keep this number in mind when you’re dealing with disgruntled customers or trying to decide your daily priorities. Do everything you can to create loyal customers!
Erica Olsen (Erica@onstrategyhq.com) is a principal of OnStrategy, which helps companies build market-focused cultures through customer-driven strategic planning, empirical market research, and measurable marketing approaches. Her company launched OnStrategy.com, an web-based strategic planning site for small and medium businesses. She is also an instructor and a writer.
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