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Updated 29 Sep 2020

How to calculate the lifetime value of a customer

Some seasoned entrepreneurs may say ‘break even’ or some other number is the most important metric, but I believe ‘lifetime value’ is perhaps the most significant measure to benchmark. 

Brad Sugars, Entrepreneur, 06 April 2015  Share  0 comments  Print

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I also know it’s one of the most overlooked and least understood metrics in business - even though it’s one of the easiest to figure out.

This number is important because it will give you an idea of how much repeat business you can expect from a particular customer, which in turn will help you decide how much you’re willing to spend to ‘buy’ that customer for your business.

Related: Managing your finances

Once you know how frequently a customer buys and how much he or she spends, you will better understand how to allocate your resources in terms of customer-retention programmes and other services you’ll need to keep your customers.

The simplest way to estimate lifetime value: Plug actual or estimated (if you’re planning or just starting out) numbers into this equation:

(Average Value of a Sale) X (Number of Repeat Transactions) X (Average Retention Time in Months or Years for a Typical Customer).

An easy example would be the lifetime value of a gym member who spends R400 every month for three years. The value of that customer would be:

R400 X 12 months X 3 years = R14 400 in total revenue (or R4 800 per year)

This is why many gyms offer a free starter membership to help drive traffic. Gym owners know that as long as they spend less than R4 800 to acquire a new member, the customer will prove profitable in a short period.

Once you have some idea of the lifetime value of your customer, you have two options in deciding how much to spend to acquire him or her:

1. Allowable acquisition cost

This is the amount you’re willing to spend per customer per campaign - as long as the cost is less than the profit you make on your first sale. This is a shorter-term strategy that makes the most sense when cash flow is a concern.

2. Investment acquisition cost

This is the cost you’re willing to spend per customer knowing that you’ll take a loss on an initial or even subsequent purchase. But you have the cash flow and other resources to absorb your initial marketing investment with this longer-term strategy.

If you can market your free initial memberships for less than R4 800 in the gym example, you can afford to expand your marketing campaign, as each new customer provides a return on your efforts.

This is great if you’re just starting out because you can develop the business by using cost-effective, measurable marketing programmes.

On the other hand, you may take a different view if you’re an established gym or the value of your customers is higher. In the end, it’s the lifetime value numbers that will determine the ultimate success of your company.

Related: Securing your first clients

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Brad Sugars, Entrepreneur

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