A common question posed to me is: “How much should I be willing to spend (or invest) to get a new customer (or client)?” This question is closely related to another common one about how to set an appropriate ongoing marketing budget.
It becomes much simpler to decide how much to invest to get and keep clients when we know how much money each of those clients means to our bottom line. If, over the course of a client’s lifetime with us, we’ll profit $100 from him, it doesn’t make much sense to invest $150 to get him. While this may sound obvious, it’s surprising how many business owners merrily go along their way having no idea what their company’s average lifetime value of a client (LTV) is. Knowing this number will go a long way to helping us determine the answer to the question posed above.
The determine LTV, follow this simple equation:
Average Transaction $
x Average # Transactions/Client/Year
x # Years of Average Client Activity
= Gross Lifetime Revenues
x Profit Margin
= Lifetime Value of a Client (LTV)
You’ll note my version of LTV is a bit different from other explanations you may have seen. Most end before multiplying the Gross Lifetime Revenues by the company’s average Profit Margin. To me it makes no sense to look only at revenues since profit margins vary so much between companies. In the end it’s all about profits, right? If this is true, LTV needs to be based on profits, not revenues.
Now you can look at the profit you’ll enjoy from a client, on average, over their lifetime as well as during any given year. Armed with this information, you can now make a much more educated decision as to what you are willing to invest to get and keep that new client.
Bryan Waldon Pope