The old axim “it takes money to make money” has been proven time and time again, but exactly how much money does it take, and more importantly, how much money does it make?
To answer these questions, we need to calculate how much your customers mean to you. Not in the warm and fuzzy sense, but in the dollars and cents sense. The technical term for this is Customer Lifetime Value (CLV), and it refers to the net-profit you make from your average customer over their lifetime as a customer.
Why is this important? If you know your CLV, then you have a pretty good idea of how to answer, “how much money does it take?” Or better yet, your CLV indicates how much you can spend in order to gain a new customer without ultimately losing money.
For example, Starbucks’s calculated average Customer Lifetime Value (CLV) is $5,500. That means if you are an average Starbucks customer they are making a net-profit of $5.5K from you! That’s more sobering than their dark roast.
How did they come up with that number? A (kinda) simple equation.
Before you can calculate your CLV , you will need to know a few things about your customers:
- Average Customer Lifespan: How long someone remains a customer.
- Average Customer Purchase: This is the amount customers actually spend with you on any given visit.
- Average Number of Customer Visits: This is the number of visits to your business that the average customer makes in any given week or month.
- Average Profit Margin per Customer: This is the average percentage of the sale price that you make in profit from each sale after all your expenses are taken out.
Now, if you are a fairly new business you might not know what some of those numbers will be. Average Customer Lifespan can definitely be a tricky one if you’ve only been in business a year. If you have been in business for a while, then you might have a better guess at these numbers even if you haven’t kept close track of them all. However, with a little imagination, you can calculate what these numbers might be.
Let’s take Starbuck’s numbers and see how they calculated their CLV:
- Average Customer Lifespan (L): 20 years
- Average Customer Purchase ($): $5.90 (Yeesh! Personally, I stick with the $1.90 black coffee)
- Average Number of Customer Visits (V): 4.2/week
- Timeframe for V (T): 52 for weeks, 12 for months
- Average Profit Margin per Customer (P): 21.3%
The equation looks like this:
L(T x $ x V x P)
20(52 x 5.9 x 4.2 x .213) = $5,489
Over the course of the average Starbucks customer’s lifespan, Starbucks will get $5,489 after all the advertising, capital expenses, and wages are paid for. And, consequently, they can afford to spend $5,489 to get and keep their average customer and still break even.
If I told you that you can spend $100, $1000, or even $5,000 to get and keep your average customer, how would that change the way you look at your marketing? This obviously doesn’t give you the ability to go out and spend the CLV of all your customers up front, but knowing the CLV for your business lets you confidently make decisions about investments for your business, including your marketing.