How do you figure out if a customer is profitable?
How do you decide how much to spend on acquiring or servicing a customer so you can maximize your profits?
This is where customer lifetime value (CLV) comes in.
CLV is essentially the total revenue you bring in from a customer, minus the cost you spend on acquiring and servicing that customer throughout the years during which the customer is purchasing from your company.
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When you calculate your customer lifetime value, you need to pay attention to the following 7 metrics -- they reveal not only the health of your business but also how you can focus your budget in order to maximize profits:
1. Customer Acquisition Cost
When you know how much a customer is worth to your company, you can allocate your customer procurement budget effectively to acquire profitable customers.
If your average CLV is $10k, then spending $1k to acquire a customer may be a reasonable investment. However, if your average CLV is $500, then you're actually losing money if you spend $1k to acquire a customer.
When you understand how much you can spend to acquire each customer and still be profitable, you can adjust your marketing and sales strategies to increase profitability.
2. Marketing BudgetDetailed customer lifetime value data can help you create buyer personas based on the most profitable customers and inform how to spend your marketing and advertising dollars to target the right audience and get the highest ROI.
When you can identify the customer segments that have the highest CLV and bring in the most profit, you can focus on acquiring more of these customers and increase your profit margin.
3. Return On Investment
Customer lifetime value metrics show you the return on investment (ROI) for your customer acquisition and retention spending and give you a measurement to evaluate how the campaigns are performing.
With this information, you can focus on areas that aren't bringing in satisfactory ROI and improve your strategies and tactics to plug the holes in your bucket.
4. Profitability of Long-Term Customers
It's one thing to talk about how long-term customers are more profitable and it's quite another when you present the concrete metrics to your management and staff.
With solid data from your customer lifetime value calculation, you can demonstrate the profitability of long-term customers and encourage a cultural change within your organization that emphasizes cultivating trust and relationship with existing customers to ensure satisfaction and loyalty, instead of just chasing short-term sales quota at the expense of identifying and servicing the most profitable customers.
5. Customer Retention Budget
No business should take its customers for granted. You need to spend time and money on servicing your current customers to make sure they come back to purchase more -- remember, the longer a customer stays with you, the more profitable the account is.
Image source: clv-calculator.com
When you understand the average customer lifetime value, you can effectively allocate budget to serve your existing customers and remain profitable.
You can also utilize the detailed data to see which customer segment has the highest CLV and designate more budget on making sure that they stick around.
6. Profitability of Individual Customers
You can get insight into how much each customer costs you to acquire and retain, how much they're spending on your products or services, and therefore the amount of profit you're making from that relationship.
This allows your customer support team to focus on servicing customers with a high CLV and identify opportunities to upsell or cross-sell for added revenues.
You can identify potential customers "just like them" so your sales team can focus on acquiring customers from those segments.
You can implement customer appreciation strategies and host customer appreciation events for your high-value customers -- not only to cultivate loyalty but also encourage advocacy and referral.
On the flip side, you can identify customers that aren't profitable and re-evaluate the relationship with them.
Your customer lifetime value is an indication of company profitability and a key data point to help project expected growth based on the value of your current customer-base.
This data is critical if you're negotiating with investors, seeking additional rounds of funding, or evaluating buy-out offers.
To sum it up, metrics from your customer lifetime value calculation can help you make important decisions that have direct impacts on your profitability:
- How much you should spend on marketing, advertising and sales to acquire new customers
- What kind of products or services to offer so you can meet the needs of your most valued customers
- How much budget to spend on servicing and retaining current customers
- What kind of customers should your sales team spend most of their time and effort on acquiring