Before you spend a buck on advertising or marketing, this is the first question: What is a new customer worth to you? We offer three metrics that will help you choose your target cost.
1. Customer Lifetime Value
CLV or LTV for short, a great calculation for a small, local business looking to set a value on a lead. It shows the present value of a customer who is likely to do business with you over a period of months or years by coming into your restaurant every weekend, ordering a major plumbing job every Thanksgiving or whatever your sales cycle. And there’s a simple spreadsheet calculator – from the Harvard Business School, no less – so you can play with scenarios.
You do need to bring an estimate of customer retention (what percentage of customers return for the next cycle), a profit margin figure and a guess at inflation rates.
What you’ll get out of the analysis is a strong sense of who are your best customers and what it’s worth to attract more like them or retain the ones you’ve got.
Read our article on CLV and see a visual representation of CLV in an infographic from Kissmetrics that uses Starbucks as an example.
2. Cost of Customer Acquisition
More of a quick and dirty than LTV, and best for figuring the value of a specific campaign. In the simplest approach, take your total sales and marketing cost—advertising costs plus salaries and overhead for sales staff, etc.—and divide that by the number of new customers acquired. So a $3,000 cost that produced 100 new customers yields a $30 cost per customer acquisition. If the average sale of your product or service is $100, congrats, you win.
3. Customer Churn Rate
What does it cost you to lose a customer? Churn rate calculation starts with the number of customers who quit you by not renewing a contract or failing to make a purchase in a certain period. Number of customers at the beginning of the period divided by number of customers lost equals the customer churn rate. You can use this simple customer churn calculator from RJ Metrics.
The news gets worse when you translate customer loss into revenue loss. Recurring revenue lost in the period divided by total revenue at the beginning of the period equals the revenue churn rate. As your customer base grows, a steady churn rate creates a larger and larger revenue loss that requires more and more revenue coming in to replace the churn. Company growth crawls. Don’t go there.
Like the LTV calculation, watching the churn rate pushes you to identify your best customers, and work to keep them in your tent—or for that matter, your worst customers whom you should encourage to churn right out the door.