Many believe that the life time value is the cumulative $ value of sales that a customer will spend over average time of dealing with a business.
However, my definition refines this further - I much rather look at the cumulative gross profit $ that a customer will provide over the average time of dealing with a business. My reason for this is that sales $ do not necessarily convert to profit $, whereas gross profit $ are just that - gross profit $ pay for expenses and provide for a profit to the owner.
So, why is the lifetime value of a customer so important?
Because this gives an indication of how much could be invested in acquiring a new customer.
For example, I am working with a client and we have determined the following:
Av $ spent per annum per customer = $500
Av. gross profit margin = 71%
Av. no. years a customer deals with the business = 5 years
Therefore, in general, each new customer is worth $500 X 71% X 5 = $1775 (= lifetime value)
We ask each new customer "how they heard about us?"
Now we know that there were 560 new customers last year - and that 7% of those came from the advertisement in the yellow pages ie 39 customers.
Therefore 39 X $1775 = $69225 of value is created for the business directly due to the yellow pages.
Question - is the $5000 investment in yellow pages advertising worthwhile? Based on the lifetime value created by that advert of $69225, the answer is yes!
Of course, this needs to be monitored constantly due the impact of changes effectiveness of media. These changes are becoming more rapid than in previous decades purely due to technological advances eg developments in social media etc
Now, what is the lifetime value of your customers? And what are you therefore prepared to spend to attract a new customer?
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