How To Measure Customer Lifetime Value
In my travels I often get asked if there is any specific criteria or formula assessed or utilized when trying to measure sales potential of a target customer?
It is good to see contractors looking to understand the marketing and sales side of the business versus just the technical aspects. This is more important than turning wrenches. Now matter how good you are at what you do, at the end of the day if you do not learn to market and sell effectively you will go out of business.
One key to getting your marketing budget right and developing practical sales forecast models demands that you understand a concept that is known as customer lifetime value, customer long-term value, customer net worth, marginal value or any of several other common names in marketing circles. Regardless of the name, it all boils down to the same thing, namely, how much a customer is worth to you over their expected lifetime.
Here's the simple method for calculating the Customer Lifetime Value:
Go back through your records and look at the cost of obtaining a new customer. First calculate your customer acquisition cost by dividing the total cost of marketing for a year by the number of customers it has produced.
What is the average initial purchase value? Look at your records.
How many times does the average customer buy again? Over what period?
What is the average purchase value of these follow-up transactions?
Total all the purchases during the lifetime of a customer.
Subtract the cost of acquisition from the profit generated from all of the purchases. This is the customer lifetime value.
If you have no historical data, make some very conservative estimates for now. As soon as you can, start recording this information for future use. Without the benefit of actual figures to work on, it's easy to over/under estimate the future value of a customer and make a wrong decision.
For example: Let’s assume you acquire and lock in the bulk of your customers via maintenance tune-ups that you marketed to generate versus demand repair service calls or replacement leads. We will also assume that with many customers moving on average every 7.5 to 10 years, many staying longer, customers dying, and customers switching to competitors, that the average customer stays with your company ten (10) years.
Most contractors today are paying on average between $250‑$350 in marketing costs for every new customer that they add to their customer base regardless of how much the customer spends. Here is a conservative tally…
- First tune-up sold $89 converts to annual maintenance agreements for ten years
- Maintenance agreement sold $200 average/year over the next 10 years = $2000
- One demand service call every 5 years @ $400 average = $800
- IAQ & Accessory sales over 10 years = $1500 x 2 = $3000
- System Replacement once in ten years @ $8500 avg. = $8500
- Total Revenue = $14,389
- Average gross margin @ 45% after commissions = $6475.05
- Less $300 acquisition cost = $6175.05 Lifetime value
- The average customer that is locked into your company for 10 years will provide an average of 4 referrals per year with a customer referral program yielding a 72% closing ratio for each referral. If just one of those referrals buys a replacement system over the next 10 years you will add another $244,060 in revenue from just the referrals of this one customer over the next ten years.
This all assumes your company has a good marketing program to generate new prospects as well as ongoing retention marketing programs to your customer base.
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