How to Calculate Customer Lifetime Value and Cost of Customer Acquisition
While it is important to focus on new client acquisition, it is equally and perhaps more important to focus on improving your relationships with your current customers. This will help you improve your customer lifetime value. Customer lifetime value is the amount of net profit you receive from each customer. As a general rule, the average customer lifetime value needs to be 3 to 5 times the average cost to acquire a customer.
Improving customer lifetime value will help you have a sustainable and profitable business. To stay in business, the net profit from each customer has to be more than the cost to acquire each customer.
Customer Lifetime Value is the average net profit that can be attributed to a company’s entire relationship with a customer. It is important to use net profit, not gross profit or revenue. If you don’t use net profit, you will over estimate your average customer lifetime value. Gross profit only includes production and sales expenses. While net profit includes product, sales, customer service, technical support, warrantees expenses, the time value of money, and more.
Customer Lifetime Value = Average Monthly Net Profit per Customer / Monthly Churn Rate
Cost of Customer Acquisition is the amount of investment, on average, required to acquire one new customer. When calculating the cost of customer acquisition it is important to include all costs associated with customer acquisition, including fixed, variable, and the cost of your time.
Fixed costs are expenses that don’t change when you add a new customer. Fixed costs include your website, sales office, base salaries, and telecommunications infrastructure. You will want to include only the percentage of your total fixed costs that are responsible for customer acquisition.
Variable costs are expenses that increase when you add a new customer. Examples of variable costs include, advertising costs and sales commissions.
In addition to real costs, you need to include the cost of your time. If you are generating your own content, building your own website, etc, you need to calculate the cost to hire someone of equal talent. Including the cost of your time, will make sure that you can profitably hire additional people.
Cost of Customer Acquisition = Number of New Clients per Month / (Fixed Costs + Variable Costs + Your Time)
Understanding customer lifetime value and the cost of customer acquisition are crucial to understanding if you have a sustainable business model. Would you like to learn how to increase your customer lifetime value and decrease your cost of new client acquisition?