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It’s obvious, but if you want a business, then you need customers.
That’s business 101.
However, not every customer is created the same.
In fact, you could do your business a disservice by focusing on the wrong customers, or spending too much to get a single customer.
But, how do you know?
It all comes back to the core question: how much is a customer worth to you?
This tiny little question will define how much you spend on marketing, the types of customers you can reach, and how much money your business makes. It’s pretty damn important.
Still, a lot of SaaS companies and startup founders haven’t set aside the time to calculate this valuable metric.
The only way for your business to grow is to analyze your own data and establish working goals from that point.
Without a clear understanding of your customer’s lifetime value it will be very difficult to make long-term business predictions.
But don’t worry that’s why I wrote this post for you.
By the end of this you’ll clearly understand why customer lifetime value is so important, and how to accurately calculate it for your own business.
Why Knowing Your Customer Lifetime Value Is So Important
If you don’t know the lifetime value of your customer, this can end up causing your business a host of problems.
By failing to calculate this metric you could end up spending more on acquiring your customers than the actual value they’re worth to your company. This only leads to one thing, going out of business.
You can’t keep the doors open with IOUs.
For instance, let’s say you’re focusing solely on how much it costs you to get that visitor to your website and purchase a single product.
But, you’re not focusing on things like, improving your products and services, deepening relationships with existing customers, or selling existing customers on new products, then you’re greatly decreasing the amount you can make from one customer.
Selling once isn’t enough.
You need to find ways you can increase the amount of money that a single customer will spend on your company, otherwise your business will forever depend on a near endless supply new business to stay afloat.
Understanding this crucial metric will help you answer key questions related to your business, like:
- Is there a cheaper way we can acquire new customers?
- How can we increase conversion to turn more visitors into customers?
- How can we take one-time customers into long-term customers?
How to Determine Your Customer Acquisition Costs
Hopefully you see why knowing your customer lifetime value is so important.
Now, for the fun part. The calculations.
The first part is determining how much is costs to acquire a new customer.
The most basic way to get this number is to divide the total amount you’ve spent on marketing by the total number of real customers you’ve acquired.
It looks like this: $2,000 spent on marketing/10 new customers = $200 CPC (Cost Per Customer)
Now, this is a rudimentary calculation, but it’s a good place to start. This will give you a rough idea of how much you’re currently spending per new customer.
We can break this conversion down even further.
Detailed CLV = ((total ad spend/new visitors) / % visitors who become leads) / % visitors who become customers
For example, let’s say you spent $100 on Facebook ads.
These ads sent a total of 50 visitors to your website.
You’re currently paying $2 per visitor. Now, if 10% of those visitors join your funnel and turn into leads, then your cost per lead will be $20.
Now, if 20% of those leads actually go on to become customers, then your total cost to acquire a customer will be $100.
As you can see, this second calculation gives us a much more accurate number of our current costs.
Of course, your numbers will differ based upon existing advertising spend and conversion rates.
Calculating Customer Retention Rate
Your customer retention rate is how long your customers will stay with your company.
if you’re just starting out, then you’ll have a hard time calculating this number.
You’ll need to have at least a few months of customer data to be able to determine how long your customers will stay with your business.
If you have that, then the calculation will be as follows:
Customer Retention Rate (CRR) = ((E-N)/S)*100
- E = Customers at the end of a period.
- N = New customers acquired during that period.
- S = Number of customers at the beginning of a period.
It looks something like this.
Let’s say you began with 200 customers, you lost 20, but gained another 30. Nice work!
The formula would look something like this: ((230-40)/200)*100 = 95% retention rate. Wow, people must love your company.
According to Peep Laja of Conversion XL, you shouldn’t be calculating this value across your entire customer base.
Instead, you should be breaking your customers down into different groups.
Understanding Your Churn Rate
Your churn rate is the rate at which you lose customers.
This is the point where a customer will eventually leave your business.
You can calculate your churn rate like this: (total number of customers lost/ending number of subscribers).
Let’s say you lost 5 customers, but ended with 103 customers, then your churn rate would be around 4.8%.
If you’re looking for a more in-depth way to calculate customer churn, then take a look at this post from Steven H. Nobel. It gets pretty heavy, but it gives you spreadsheets to make your calculations much easier.
Calculating Your Customer Lifetime Value
Finally, it’s time to bring it all together.
Now that we have an understanding of how much you’re spending to acquire new customers, how long they stay with you, and the percentage of customers that leave your company we’re going to combine this with existing company data to calculate a more accurate Customer Lifetime Value (CLV).
It looks like this: (value of a sale) * (number of repeat transactions) * (avg. retention time)
Let’s say you have an app that costs $5/month and your customers stay with you for 5 years. That would be $5 * 12 months * 5 years = $300 customer lifetime value.
Now, this is a total average. Not all customers will end up staying with you for 5 years, although that would be nice.
To get a more accurate picture, you’d want to include other upsells and purchases your customers buy, and the purchasing patterns of different customers.
For example, customers acquired through content marketing may stay with your company longer than those who find you via Facebook ads.
Since your business will probably deal with multiple customer segments, you’ll want to segment your calculate your customer lifetime value per type of customer.
If you’re looking for a visual breakdown of how this process works, then check out this infographic from Kissmetrics.
Overall, calculating your customer’s lifetime value can get quite complex.
But, the calculations above will give you enough to work with, so you can determine how much you should spend to acquire a new customer, while keeping your business in the red.