Do you know how much each of your customers is worth to your business?
Chances are your best customers are worth more to your company than your worst customers.
Your customers are the heartbeat of success for your business.
The type of customers you attract and retain in your business will be one of the most important factors for your business’s success.
These customers will contribute to your business’s profits.
Remember that profit is the number one indicator of success for your business.
Never lose sight of this important success metric.
How do you know if a business is profitable?
There is only one true sign of profitability that matters.
Cash in the bank.
If there isn’t cash in the bank, then the business is not profitable.
It is as simple as that.
No cash = no profit.
Don’t let anyone with a fancy education or certification tell you anything different than that.
Cash is king.
Always has been.
Always will be.
Here is another piece of flawed thinking I’ve frequently heard business owners tell me.
My business has cash flow problems.
I always respond respectfully.
What they really have is a profit problem.
If their business were profitable enough, it would have cash in the bank.
Profit is the most important indicator of success in business.
I’ve known several business owners that focus on sales growth.
Many times, these people are chasing sales at all costs.
They may sell their goods and services at a discount to capture market share or to acquire more customers or to add people to their list.
Often, this growth strategy focuses primarily on the front-end stage of a customer relationship,
This growth strategy can be successful when there is a backend revenue or recurring revenue stream associated with that customer relationship.
This is where the valuable concept of the lifetime value of a customer becomes important.
The lifetime value of a customer is a calculation of how much money a customer is worth to the company.
With accurate knowledge of how much a customer is worth to a company, the business now knows how much it can afford to spend to acquire a new customer.
Let me give you an example of how this concept works.
For this example, we are going to use a local coffee shop to illustrate how the lifetime value of a customer concept works.
Here are some of the background details that we’ll need to understand for this example.
The coffee shop sells two drinks – a hot brewed coffee for $3 and a cold-brewed coffee for $5.
The costs associated with both coffee drinks are 5 cents for coffee & water and 5 cents for the cup.
The total cost for a cup of hot brewed coffee and cold-brewed coffee is 10 cents.
This means that the company earns the following for each coffee drink:
- Hot brewed coffee = $2.90 ($3 sales price – 10 cents coffee and cup costs)
- Cold-brewed coffee = $4.90 ($5 sales price – 10 cents coffee and cup costs)
The operating costs of the store are $1,500, which includes employees, building rent, utilities and materials.
For this example, I’ll separate marketing costs from operating costs. The reason for this will make sense later.
Now, for the company to reach the breakeven point (the revenue point where total sales = total costs), the company must sell the following amount of coffee drinks:
- 518 hot brewed coffees ($1,500 divided by $2.90)
- 306 cold-brewed coffees ($1,500 divided by $4.90)
Once the coffee shop sells the 518 hot brewed coffees or the 306 cold-brewed coffees, each cup of coffee sold becomes pure profit.
Coffee is a consumable product that people buy every day, which makes for a wonderful recurring revenue model for our coffee shop.
Now let’s look at how the lifetime value of the customer plays into the success of our coffee shop.
We have four types of customers in our example.
- Customer A who buys one hot brewed coffee five days a week.
- Customer B who buys one cold-brewed coffee five days a week.
- Customer C who buys two hot brewed coffees five days a week.
- Customer D who buys two cold-brewed coffees five days a week.
Now we will talk about the longevity of these customers. Each customer will stay a customer for one year.
Here is how much each of those customers is worth to the company.
- Customer A has a lifetime value of $754 ($2.90/cup x 5 cups/week x 52 weeks).
- Customer B has a lifetime value of $1,274 ($4.90/cup x 5 cups/week x 52 weeks).
- Customer B has a lifetime value of $1,508 ($2.90/cup x 10 cups/week x 52 weeks).
- Customer B has a lifetime value of $2,548 ($4.90/cup x 10 cups/week x 52 weeks).
Now, this is where things get interesting.
How much would we be willing to spend to acquire that customer?
In each of the scenarios, the company is making money in acquiring their customers.
Think about it this way, if you were to go to the bank and give them $500 and they give you $754, how many times would you give the bank $500?
I would give the bank $500 as many times as I could because every time I give the bank money, I come out ahead.
Here is a scenario where I would not give the bank $500.
When they only give me back $499.
I probably wouldn’t even give the bank $500 if they only gave me $500. It simply would not be the effort to drive down to the bank.
Why do I bring up this example?
This is what happens when we invest in marketing that works.
Notice I said marketing that works.
When we invest in marketing, we are investing in customer acquisition.
We are buying customers.
When business owners don’t take the perspective of the lifetime value of a customer, they have a short-term view of marketing.
I mention this because I’ve been guilty of this short-term in the past.
Here is where I’ve failed with my marketing.
I looked at how much money I made from an initial sale.
In my example, let’s say I make $100 per month from a customer, and that customer stays with me for five years.
The lifetime value of my customer is $6,000.
Now, if I were taking a long-term approach, I would be willing to invest a lot more in marketing to that customer.
Let’s say I am willing to spend $1,200 to acquire that customer. In this example the lifetime value of that customer is now $4,800 ($6,000 – $1,200 acquisition cost).
I have received a 400% return on my $1,200 investment.
If I was taking a short-term view of this customer, I might not be willing to invest the $1,200 because I would be losing money for 12 months before I started making money on this customer.
However, If I look at the long term and the lifetime value of the customer, it becomes a wise no-brainer decision to invest that $1,200.
By taking a long-term view of the lifetime value of each customer, I’m able to start investing in the marketing and growth of my company in a financially responsible manner.