Improve Your Business Profits By Calculating The Lifetime Value Of A Customer
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Business > Entrepreneurs
Jun 19, 2007
dave21
Improve Your Business Profits By Calculating The Lifetime Value Of A Customer
Small business owners, home based entrepreneurs, and online business owners are always looking for ways to improve their profits. Let us start our discussion by estimating The Lifetime Cash Receipts Value of a new customer for your business. We need to use a two step procedure. Step #1: Estimate, on average, how much a new customer will spend with you for one year. Step #2: Estimate, on average, how many years a new customer will stay with your business firm. Let us use an example to make the calculation. We will use Starbucks Coffee Shops to illustrate the calculations involved. Let us say the typical customer spends $5.00 per trip and she comes in four times per week, or spends $20.00 per week. Also, she comes in fifty (50) weeks per year. Accordingly, she spends $1,000 per year ($5.00 times 4 times 50). We now know that a new customer for Starbucks will spend $1,000 in cash for her coffee. That is the first step. The second step is to estimate how many years she will continue to visit Starbucks. That answer is twenty-five (25) years. We know the life-time cash receipts value of a new customer is $25,000. Now, you understand why Starbuck employees treat each customer like he or she is like a king or queen. Note: The author simply used Starbucks as an example. I am a customer and simply used my best guess. The actual number is known only by Starbucks management. The challenge is for you to estimate The Lifetime Cash Receipts Value of a new customer for your business. If you are an internet based business, what is the cash receipts value of one new customer for your business? If you have a home-based business model, what is the magical number? The cash value will be different for each industry, but the concept is valid for each different industry. And once you know the life-time value you can use it to make advertising, selling, and marketing decisions. How much are you willing to spend to acquire a new customer? How much will your competitor spend to take a customer away from you? If you lose a customer, for whatever reason, what does it cost your business in lost profits? How much do you lose the first year? How much do you lose over the life of the customer? Let us go back to the Starbucks example to calculate the lost profits. Let us assume that the typical customer makes a 50% contribution to overhead and profits. We use this percent and multiply times the first year sales estimate. We said earlier that the typical customer would spend $1,000 per year. By multiplying 50% times $1,000 we arrive at an estimate of $500 per year. In other words, we lose $500 in contribution to overhead and profits for each customer lost. If we lose 10 customers to the competition, then we have lost $5,000 in contribution to overhead and profits. That number is arrived at by multiplying 10 times the $500 per customer. Also, if we lose 100 customers, then the lost profits become $50,000 per year. Clearly, it is very expensive to lose a customer for whatever reason. What about the lost profits over the life of the customer? Earlier in our discussion, we used twenty-five (25) years as the useful life of a customer. We would multiply the $500 per year in lost profits times 25 years, which would be $12,500 per year. In my opinion, losing $500 per year per customer for twenty-five (25) years is a substantial loss of profits. And when a customer is lost due to poor customer service by an employee, it is almost unacceptable to the owner/management team. Small business owners, home based entrepreneurs and online business owners are always looking for ways to improve their business profits. By calculating the Lifetime Value of a new customer, then the owner/entrepreneur can start making better decisions about sales and marketing activities, especially customer acquisition and retention. And I will conclude this article by asking a question. What is your plan to calculate the life-time value of a new customer for your business?
David Wiley, MBA, specializes in teaching individuals the creative internet tools they need in order to earn a six figure income online. Go here for his free series of email letters: http://www.dwphbs.com/onlineincome.html Visit his main website here: http://www.dwphbs.com Copyright 2007
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