Monday, September 20, 2010

How Much Should I Spend to Get a New Customer?

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


  1. Hi Bryan - I like your reasoning about tying the LTV to profits rather than revenues. In your experience, have you noticed an average investment % based on LTV?

  2. Ben and Robyn,

    While there is, undoubtedly, an average investment percentage (if we had the time to gather enough data) based on LTV, that average isn't something we should pay attention to. Here's why:

    Every business has widely varying repeat purchase cycles. Further, a bottom-line profit percentage or dollar amount means something different to every business based on their model, overhead, and so on. The investment level to gain a new client, therefore, becomes very personal.

    Let's look at the rental industry. If the average client rents twice a season, one can afford to give up a larger piece of first-season profits to gain a new client than if the average client only rents once. Where is the bigger money, investing half of first rental profits on a single rental for the season, or investing all of first-rental profits on two rentals for the season? The latter scenario garners twice the profit dollars.

    The answer to your question is arrived at by looking at your specific situation and determining the investment level that makes sense. Some invest part of first-transaction profits to gain a new client. Some invest all of first-transaction profits. Yet others invest all the profit from a number of transactions. It all depends on your staying power, level of competition, purchase cycles, and profit levels.

    I wish I had a cut-and-dried answer for you, but I'm sure you can see why that isn't possible (or even wise). If I've created more questions than I've answered, jump back in and let me know so we can get you to YOUR answer.

  3. Thanks for the reply, Bryan! And thanks for following up with an equally insightful post this week. Keep 'em coming!