It's clear that keeping customers brings tremendous value to the firm. But how much?
We marketers should know the answer, because the CEO and Board want to know. And our programs will be effective only if our decisions are guided by information.
There are myriad ways to calculate the lifetime value of a customer to the firm. No matter the measure, producing a concrete dollar figure gives management a tangible pivot point around which to design customer retention strategies.
Below is a simple calculation that your firm can use to calculate the lifetime value of a customer.
The Variables
Below are defined variables that go into the calculation to determine the lifetime value of the customer. Don't be put off by the letters; they're merely a simple way of defining which numbers to insert where.
S=The average revenue generated by a customer per visit to your firm
C=The average costs of servicing the customer per visit
V=The customer's expected number of visits per year
Y=The expected number of years the customer will use your services
A=The costs of acquiring a new customer
N=The number of new accounts the customer refers to you
F=The correction factor for the time period analyzed
The correction factor (F) captures changes in a customer's behavior over time. If you estimate that the customer will increase the money spent per visit over time (because you estimate you will increase their loyalty), then put in a higher number—say, 1.4. If you estimate the customer will decrease their spending over time, put in a lower number—say .9. This is obviously a subjective estimate.
Simple Calculations
Before we get to the total equation for figuring the lifetime value of a customer, we can gain a lot of information from some simple preliminary equations:
S-C=Average gross margin generated by the customer per visit
VxY=Total number of visits over the customer's lifetime
AxN=Amount of money saved by the customer's referral
If we put these simple equations together, we can determine the lifetime value of the customers:
Lifetime Value of the Customer=[(S-C)x(VxY)-A+(AxN)]xF
An Example
We can see the true value of this equation with an example:
Average revenue generated per visit: $50
Average costs of servicing the customer per visit: $4
The customer's expected number of visits per year: 24
Expected number of years for the customer's patronage: 40
Costs of acquiring a new customer: $15
The number of new accounts the customer refers to you: 4
Correction factor for the time period analyzed: 1.1
We plug these values into the equation and get the following:
[($50-$4)x(24x40)-$15+($15x4)]x1.1=$48,626
Conclusion
That number represents a relatively accurate estimation of your customer's value to your firm over the course of the customer's lifetime.
When designing long-term strategies or assessing the cost of losing customers, this equation can provide a sobering illustration of the results of your efforts.
And you can then better guide your firm toward the kind of success it desires.
