How to Calculate Lifetime Customer Value, Part 2 of 2

Valued Customer

Valued Customer

In “How to Make Money by Losing Money,” we introduced the concept of back end sales, and suggested it was worth giving away a $400 (retail) cellular telephone in order to get a $100 per month cellular telephone service contract.

How did we know? We simply subtracted the cost of the premium (the front end transaction) from the sum of back end profits over the lifetime of the vendor/customer relationship. In Part 3 we’ll learn how to use the Customer Lifetime Value to calculate useful things, like ad budgets.

Our hypothetical telephone company is a small start up. It has 3,500 customers, each locked in to a twenty-four month service agreement. The company’s net profit is $297,500 per month.

Over the first year of the contract those 3,500 customers will produce $7,140,000 in profit – approximately $1,020 each.

They will also produce $955 each in the second year. (There will frequently be a difference between year one and year two. More on that in a minute).

This means that even if every single customer stops doing business with this company, the lifetime value (profit) of every new customer this phone company can acquire is still $2,040.

Calculating LCV for your business.

This LCV number is important. Without it we can only guess at how much we are able to spend to acquire a new customer.

A. What is the profit on your average sale? $ _________

B. How many times will the average customer repurchase from you? _________

C. Multiply A by B to estimate your average customer’s lifetime value. For your company that value is: $ _________

Lifetime Customer Value = Pt (profit per transaction) x R (number of customer reorders)

Of course, this is overly simplistic.

In the real world, Lifetime Customer Value is a moving target.

Under most conditions, not all of those cellular telephone customers will complete all 24 months of the service agreement. If 14 percent cancel during the first 12 months, 3,200 customers will enter year two of their relationship with the cellular provider.

At the conclusion of the second year we can estimate that, freed from their mandatory minimum service agreement, 70 percent will either upgrade to a new phone with the same company, or sign with a competitor. Either way, they’ll be entering into a new 24-month agreement.

But the remaining 30 percent will appreciate the month-to-month nature of their new relationship with their cellular provider. 1,050 will enter year three with the company.

Also, the profit margin actually increases the longer a customer stays a customer, since older customers tend to consume fewer support services.

So, applying a bit more accuracy to our figures, the actual customer lifetime is three years. She’ll generate $2,205 in value to the company during that lifetime.

Calculating Customer Reorders for your business.

Your average sale figure is pretty straightforward. Simply divide total revenue by number of transactions. Estimating the number of times a customer will make another purchase is a bit more difficult.

You could divide the number of total sales by the number of customers, but that leaves us with a bit of a problem. Can you spot it? Exactly. Newer customers will not have ordered as many times as a long-term customer would have.

We’ll get more accurate data if we remove data from all customers who have not finished their relationship with you. But that means you must already have a good estimate for the length of time a customer is likely to continue to purchase from you. And if we knew that, we wouldn’t have to estimate. (Author makes “I’m going crazy” sound of index finger thrumming on lips).

OK. Let’s reconsider.

If you’ve been in business for several years, you can create a fairly accurate estimate by removing from your list of customers any who haven’t ordered anything from you in the last 12 months. Now, select every fifth (or seventh, or thirteenth) remaining customer until you’ve created a significant sample. Fifty may be acceptable. One hundred is much better. The larger the sample, the more accurate your results.

Calculate the number of days between each customer’s first order, and their last order with your company.

D. What is the number of days between the first purchase and the last for each customer in your sample? ___________

E. Sum the number of days as customers from each customer sample. The total is: _________

F. Now divide by the number of customers in your sample. ___________.

This is the average length of a customer relationship, in days. If you’re a younger company and don’t have records going back years, study your sales data. As closely as you can, estimate the length of the average customer relationship, in days.

G. Whether calculated, or estimated, how many days does this work out to be for your company? __________

Trim the database.

From your complete customer database, remove all data back as far back as the number of days in your average customer relationship. Count the number of sales transactions which remain, back to day one. Count the number of customers which remain, back to day one.

H. For your company the number of sales is: __________

I. For your company the number of customers is: __________

Divide the remaining total sales by the remaining number of customers and you’ll have a highly accurate customer reorder number.

J. Divide H by I. The average number of reorders for your typical customer is: __________

The final step.

Divide the average profit per sale (from A, above) by the average number of reorders (from G).

K. That number, your true lifetime value of a customer, is: $___________.

You can add a degree of sophistication (and accuracy) by discounting the value of future cash flows. It’s a bit complex, but if you’re curious, drop me a note.  And knowing what you can invest in bait and still profitably reel ’em in  gives you a major advantage when you’re fishing for customers.

Your Guide,
Chuck McKay

Marketing consultant Chuck McKay

Chuck McKay

Your Fishing for Customers guide, Chuck McKay, gets people to buy more of what you sell.

Questions about focusing your messages on specific stages of shopping may be directed to ChuckMcKay@FishingforCustomers.com. Or call Chuck at 304-208-7654.

 

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How to Make Money by Losing Money – Part 1 of 2

Light Bulb with Dollar Sign

Money Idea!

Would you buy a dollar for 50 cents?

OK, that one was easy. If you could hand me 50 cents, and get a dollar back every time, you’d push as many fifty cent pieces in my direction as I’d be willing to accept.

What about for 99 cents? Would you be as excited about that exchange?

Maybe. As long as there’s a profit to be made you might be willing to make it slowly.

How about $1.35? Could you imagine spending $1.35 to get back one dollar? Your first reaction is likely “no,” but the correct answer isn’t so obvious.

How could anyone stay in business losing 35 cents on the dollar?

Pretend with me that your music store consistently sells twelve guitars a week, at an average price of $850, and an average profit of $332 (39 percent).

You’re planning an Anniversary Week guitar sale, and have budgeted $10,000 for advertising. Knowing that you’ll get to keep 39 cents of every dollar you take in, it would seem that to recover your $10,000 advertising investment you’ll need to generate $25,641, or roughly 30 additional sales (for a total of 42) just to break even.

But wait a minute. Selling 42 guitars this week doesn’t have you showing a profit. You’re merely recovering your costs.

And what happens if you don’t sell 42 guitars? Wouldn’t you have been better off not advertising this sale at all?

Maybe we need to re-think this Anniversary Week sale idea.

Then again…

We probably will sell a lot of accessories. We’ll probably draw some new people into the store, and remind former customers that they used to enjoy shopping with us.

OK. Even if we can’t sell enough guitars to pay for the Anniversary sale advertising, we might sell enough other items to recover the ad budget.

And then there are the rumors of the way the new competitor does business. You’ve heard he will happily lose money on the first sale if he gains a new customer in the process. What the… How can anyone stay in business with a silly business model like that?

Well, your competitor has recognized that the customer who buys the guitar will also need a case, maybe a strap. Over the next weeks he’ll see the value of a battery-powered tuning standard, or a capo. He’ll need picks, and strings. Over his lifetime as a player, he’ll need lots of strings.

Then, too, over his lifetime as a player, he may purchase several other instruments, and all of the accessories. Maybe he’ll even need lessons.

If a business is willing to invest money in advertising to gain new customers, why not invest in the customer himself?

When we consider the probability of all those additional purchases, and all of the profit derived from them, would you be willing to lose a few bucks on the “front end” of this relationship to “buy” the customer, and gain a profitable “back end?”

Twenty years ago Jay Abraham brought up the concept of back end sales by telling the story of a coin dealer. The dealer offered a $23 starter coin set at cost, and gained 60,000 new customers.

  • Within six months, 6,000 of those 60,000 new customers each bought another $1,000 worth of coins. 
  • Two months later 2,000 of the 6,000 customers each purchased roughly $4,000 in additional coins.
  • Finally, 500 of the 2,000 bought another $10,000 each.

By being willing to break even on the initial sale, the coin dealer was able to generate a list of qualified customers who were responsible for $19 million dollars in additional sales:

Jay Abrahan's Coin Upsell data

Jay Abraham's backend coin upsell data.

And this part is critical: every one of the 60,000 names on the initial list turned out to be worth $317 in additional sales, even though nine out of ten of those new customers never spent another dime.

This is a great illustration of Lifetime Customer Value (LCV).

Make your profit on the back end.

How many customers would you be willing to sell at no profit, if it meant each would directly or indirectly generate $317 in new sales in the next year?

Would you maybe even be willing to lose money on the front end, if there was enough profit on successive back end deals?

  • Would you give away the $400 (retail price) cellular telephone, in order to gain the 24-month usage contract at $100 per month?
  • Would you give away the new $60 (retail) chrome plated coffee brewer to gain a customer who spends an average of $234 on your gourmet coffees?
  • Would you be willing to sell gasoline at an average profit of $14.32 per month (four, 20-gallon tanks), when that driver will spend an average of $31.92 each month in interest and carrying charges on your company credit card?

Yes, I suspect you would.

Next time, in How to Calculate Lifetime Customer Value, we’ll determine in dollars and cents the value of each new customer. We’ll also get a handle on how long that new customer will continue to do business with us. An important consideration when one is fishing for customers.

Your Guide,
Chuck McKay

Marketing consultant Chuck McKay

Chuck McKay

Your Fishing for Customers guide, Chuck McKay, gets people to buy more of what you sell.

Questions about making money on back-end sales may be directed to ChuckMcKay@FishingforCustomers.com. Or call Chuck at 304-523-0163.

 

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Cherish Your Existing Customers – Surviving the Recession – Part 2 of 7

How many times have we read that it costs 5 to 7 times as much to acquire a customer as it does to retain one? And yet, knowing that existing relationships are more profitable, we spend the majority of our planning and budget on new customer acquisition.

Unless you’re a brand new company, quit it. Until you’ve optimized profitability of your existing relationships, you’re wasting resources.

What are you doing to make your customers feel appreciated? Don’t have time? WRONG! Appreciating people adds directly to your bottom line for three excellent reasons:

1.Your best customers buy more often
2.Their average purchase is two-thirds greater
3.They refer others in greater number 


I love the Ritz Carlton’s formula.

They offer a warm and sincere greeting, using the guest’s name when possible. They pride themselves on anticipating the needs of each guest. They offer a fond farewell at the end of each guest’s stay.

Do you treat every customer as if they were your best customer? Maybe it’s time. Some of these basics should be automatic. Respect your customer’s time. Keep your promises. Keep your customer in the information loop. Deliver the same day your customer purchases. Show genuine interest in your customer’s satisfaction and success.

Look for additional customer touch points. Send “thank you” messages. Send birthday cards. Ask your customers about their dealings with your company, and ask their advice. Its flattering to be asked. Gather, analyze, and act on their feedback. Not only will your customers feel as if you consider their opinions valuable, you’ll also improve your service.

You plan to remember special dates for your friends and loved ones, don’t you? Birthday card for Grandma has to be mailed by Friday? Call your brother on his birthday? What are we going to do for the folk’s anniversary?

Do you know your customer’s birthdays? Hummm. Well, you do know the anniversary of their first purchase, don’t you? Why not? Send a “You’ve been our customer for a year, and we appreciate you” card. Drop a hand-written post card to your best customers telling them of the new inventory you’ve just received. If you think about it, there are dozens of reasons to contact your customers.

Back to anticipating your customer’s needs:

Do you sell products in a predictable order? Does your homeowner customer typically purchase a lawnmower, then a chainsaw, then a brush cutter? Send information about the next probable purchase to customers who haven’t even asked about it, yet.

Is it likely that your customer needs accessories when she makes a specific purchase? If she’s just bought a laptop computer, does she need a docking station for her desk? Does she need an MP3 player to store her downloaded songs? Would she appreciate a kit of cables, blank recordable media, and rechargeable batteries?

Can you introduce your customer to your service manager, and schedule her first preventive maintenance appointment?

As your customers own and use your products, they’ll learn of other needs they haven’t even suspected, yet. Help your customers to buy more from you by helping them to anticipate.

And when you screw up?

Proactively taking care of a customer’s problem can actually improve your relationship. Customers expect you to care. They prefer you to competently fix their problem, now.

One of the best customer service formulas is “Whomever takes the call owns the problem.” In other words, the employee who is dealing with the customer is not allowed to pass that customer off to another employee. Of course, that also means you have to delegate authority to your employees to accompany the additional responsibility.

Owning the problem means making it personal. Not “We’re sorry,” but rather “I’m sorry. I will fix this for you..”

What are your customers worth?

Don’t know? Here’s a tool from Harvard Business School to help you with your calculations.

Last thought (for today):

No more excuses. Buy a box of “Thank you” cards, and start sending them today.

__________

Chuck McKay is a marketing consultant who helps customers discover you, and choose your business. Questions about helping your business thrive during an economic recession may be directed to ChuckMcKay@ChuckMcKayOnLine.com.

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