Do you know exactly how much a new customer is worth to your business? Very few business owners do, but all should. Not having this information at hand makes determining your return on investment (ROI) on projects and advertising impossible. Your final decisions will be based on guessing and hunches rather than on real numbers. More importantly, studies have shown that business owners who know how much a customer is worth have a much higher customer value compared to those that don’t. Knowing what your customers are woth allows you to make smarter data-driven decisions, and enables your business to more profitable. Here’s how you can determine quickly exactly how much a new customer is worth to you and your business.
How to Calculate Your Customer Value
A new customer is worth $624 for Larry’s Landscaping, an imaginary Cecil County company.
Calculate Average Customer Lifetime Value
In its most basic form, the formula for calculating the value of a customer is simply this:
Customer Lifetime Value = Sale Price – Cost of Goods Sold
Now if you only sell one thing one time to a single customer, this makes your calculation really easy. In most businesses, you’ll need to add a little bit to this.
How long does a customer typically buy from you? How many purchases would you anticipate from that customer during that period of time? The purchases over this span of time get added into the sale price and cost of goods sold in the formula above.
Customer Referrals and Customer Lifetime Value
How much of your business is from word of mouth referrals? If you receive a substantial amount of business as a result of the recommendations given by current / previous customers, then this needs to be reflected in your Customer Lifetime Value (CLTV or sometimes known as LTV) calculation.
How frequently do your customers refer other customers to you? Do you have great customer service and reputation and do great in referrals? How many new customer referrals would you expect to receive from one customer? Ideally, you are tracking this information, but if you’re not yet doing this, just guestimate it. If 1 out of every 3 customers gives you a referral, then your customer referral rate is 33%. The percentage of customers who will refer new business to you gets added into the CLTV formula as follows:
Customer Lifetime Value = ((Sale Price – Cost of Goods Sold) x (1 + Referral Rate)).
Example – Larry’s Landscaping
In Larry’s Business, Larry’s customers buy only once from him. His typical sale ranges from $300 – $1,000. This works out to an average sale price of $650. His labor and materials is usually around 36% of the sale price. This works out to $234 for cost of goods sold on an average sale price of $650. Larry’s customers are very pleased with his work and 1 out of every 2 customers refers another new customer. His customer referral rate is 50%. With this information we can now calculate that the lifetime value for Joe’s customer is $624.
CLTV = (($650-$234) x (1+.50))
Armed with this information Larry can now make smarter decisions for his company. He can make advertising decisions based on this hard data and not guesses and hunches. Once you know your customer value, you can begin tracking it more closely and learn to increase the value you’re providing to customers. As you increase the value that you’re providing, your customer will increase. Knowing the value of a new customer is essential to increasing the return you receive on your advertising, SEO, or web design investments.