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Part 2: Calculating Lifetime Value of Customers – a simple example

At the most basic level calculating the lifetime value of customers can be done using some assumptions and a simple spreadsheet like the one below:

In the above example I have used a yoga studio as an example with 100 customers in its first year. To keep things simple I have not leveraged all the data for the calculations but you can draw a couple of key points from the data:

Firstly – The lifetime value of a customer to a yoga studio can be very significant, the average customer in this example is spending almost $2.5k over a four year period! Understanding this bigger picture allows us to make better decisions about the value and importance of even a single customer to our business.

Secondly -Acquisition costs a usually higher than retention costs, in this example it costs a full 100% more to acquire a customer than to retain one. The economics demonstrate the value of customer retention. Of course this will vary from business to business but regardless this is an important data point to understand.

Calculating your own lifetime value of customers

The key inputs relate to estimating the probabilities of the impact of our sales and marketing activities on customer acquisition and retention.We then marry this with some hard data, i.e, the costs associated with these activities.

So what information do we need to begin the analysis?

1. What is the average revenue (spend) and gross margin per customer?

2. What does it cost to acquire a new customer for the first time?

3. What does it cost to retain a customer each year?

4. How often do customers purchase in a given year?

5. How many customers do you have right now and how many do you gain and lose each year?

Note: For this example I did not use a discount rate but as a side note we should be accounting for the time value of money. In other words a dollar today is worth more than a dollar in a year or 5 years time.

If you would like access to the spreadsheet you can sign up for free at our easyLearn website here.

Part 1: Understanding Lifetime Value of Customers

This is a simple business concept that is not necessarily that widely known. Intuitively we understand that customers that are loyal and keep coming back are the heart of business. However when was the last time you quantified this value? When you take a look at the numbers if becomes clear that managing customers as real assets is a powerful way to grow profitably.

Take the following chart for example:

You can see that if you provide a product or service with real tangible value to customers they will not only buy more from you but tell everyone they know to buy more from you. They also tend to be more interested in other products and services you offer. Plus as they become familiar with you it costs you less to service their business as they know how you operate.

The very best modern example of this on a mass scale is Apple, customers are attracted by the iPod, transition to an iPhone and or an iPad then get interested in a Mac computer… a virtuous cycle that has seen Apple’s revenue and profit grow exponentially over the past 5 years with no signs of slowing.

In the next post we will take a look at how you can calculate this for yourself.