Reference no: EM131917849

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In the management of a small business or department, understanding the "costs" can make all the difference to your bottom line, especially in relation to how much you budget for your advertising and promotion. Many people simply calculate how much their product costs to make, how much it costs to deliver, how much they have in overhead costs, and how much profit they need to make. Then, they decide how much of the remaining margin to budget for advertising, promotion, social media, marketing, etc.

Unfortunately, that approach doesn't consider the total monetary value of a customer to the business and, as a result, doesn't allow you determine how much to spend on acquiring a new customer and keeping a current one. To do this, we need to look at the marginal value of each customer over the lifetime of that customer.

Example: Let's say you're an acupuncture physician and your patients come to you for an average of 5 years, typically having 2 visits with you each month. For each visit, they pay $100 for a treatment with the direct cost per visit being about $25.

Many small business owners would focus their calculations on how many patient visits they have per month, subtract out the various costs, consider their desired profit, and then decide how much of the remaining amount they could use for their marketing expenditures. As mentioned previously, such a practice doesn't necessarily consider the lifetime value of each customer and thus won't provide you with insights to determine how much you can and should spend on targeted marketing and promotion.

So how much can and should you spend on acquiring a new client?

Let's look at a simple formula that provides real insight on the how much monetary value each client brings and consequently how much you might spend on acquiring that client proportionately. You'll need the following figures (they can be estimates):

Revenue Per Purchase: this is the average amount your customer will pay you for each visit or purchase.

Direct Costs Per Purchase: this is the average cost to the business for each visit or purchase, and includes both the costs of physical goods and of services rendered.

Projected Lifetime Purchases: this is your estimate of how many visits or purchases each customer will make over their "lifetime" (meaning the lifetime of their business with you). An easy way to calculate this is to consider how many visits or purchases a customer makes each week or month or year and then determine how many weeks/months/year they will do business with you (their lifetime as a customer).

Now all you do is subtract the Direct Costs Per Purchase from the Revenue Per Purchase and you'll have the Contribution Margin Per Purchase. Multiply this result by the Projected Lifetime Purchases and you'll have an estimate of the Customer Lifetime Value. (Granted, you can make this more accurate, and more complicated, by discounting future purchases by the time value of money, but this can serve as a rough estimate.) Using our example from above, we have the following:

Revenue Per Purchase: $100 per acupuncture visit

Direct Costs Per Purchase: $25 per acupuncture visit

Contribution Margin Per Purchase: $100 - $25 = $75 per visit

Projected Lifetime Purchases: 2 visits per month x 12 months per year x 5 years = 120

Customer Lifetime Value: $75/visit x 120 visits = $9,000 per patient

Now that you've found that each new customer will add an estimated $9,000 in Contribution Margin (that's spendable money) over their 5-year customer experience, you're equipped to ask the right question: How much can and should you spend to find and also keep that customer?

The answer might depend on how many customers you currently have, the amount of your fixed costs, potential capacity constraints, and the nature of your competition. But at least you now know that if you spend an average of $1,000 to attract and keep a customer (with a variety of "free" group classes, direct mail pieces, social media interactions, telephone calls, etc.), you'll still be receiving an additional $8,000 from the customer that will contribute to your fixed costs and/or profit. This is information that you would not have known if you hadn't calculated some estimate of customer lifetime value.

Too many marketers skimp on their expenditures to acquire, and particularly to keep, their clients. This is a huge mistake in that adding a few more benefits to your client's value portfolio can have a significant effect on how the client values your services, which can have a meaningful effect on the client's loyalty to your business.

If you take the time to calculate the long-term value of your clients combined with the cost of the right marketing strategy at the right time in the right way, your clients will stick with you for a much longer time. When you understand their value to your business, you'll be more willing to provide them with additional benefits, which will help them feel valued as customers and as people. And that's what marketing is about!

P.S. While the focus of this article is on the monetary value of each customer, it's important to remember that there are a number of non-monetary value factors that each customer brings. But those are a topics for a later date.