Understanding Customer Lifetime Value is key to your company’s successGo to the news page
Some companies start with a great idea. They might try to make it happen, to “follow the dream”, which can make for a wonderful story.
However, a business needs more than a dream to believe in; It needs to be financially viable. And a crucial part of financial viability is to be profitable on a customer level, allowing you to scale and eventually generate a profit overall.
Understanding customer lifetime value (CLTV) is key to any successful company. It’s crucial to a building, scaling and managing your business. This business concept consists of three main parts: the acquisition cost, the service cost and the revenue from the customer paying for the service. Let’s start with the first step: acquiring customers.
Customer Acquisition Cost (CAC)
Even if your business is ready to change the world, customers don’t just line up to do business with you - it’s going to cost you. The cost associated with acquiring a new customer includes typically:
- The marketing cost (mostly promoting and advertising)
- The sales cost (primarily made up of salespeople and commissions for direct and indirect sales)
- The cost of boarding the customer or delivering the product or service.
Here is a key point to remember: The more money spent to add customers, the lower the customer profitability and the greater the likelihood of having a negative gross margin overall. So, identify right away how to get the most profitable customers for the lowest acquisition cost. Usually, casting a wide net across many channels and then determining what’s most profitable will help you know where to put your marketing and sales efforts. If possible, try and defray as much of the acquisition cost over time (e.g., paying the commissions for customers added in instalments).
Because customer acquisition can make or break a company, marketing departments should be as numbers-driven as the finance department to hone in on quality customer leads. Remember, these quality leads eventually become quality customers. So measure the spend-to-lead generation by channel to identify what’s most cost-effective for acquiring customers.
The last opportunity in acquisition cost is a bit trickier: building “acquisition infrastructure”. This means making one-off investments into things that generate ongoing leads for a low-recurring cost. Things like referral websites, affiliate networks, partner agreements and memberships in organisations can introduce you to potential customers. Doing so will give you the advantage of enabling you to scale your marketing investment.
Understanding all of the costs of keeping your customers happy will keep your company’s head above water. The service cost includes the customer support team, software licenses, operations activities, etc. and are generally based on units allocated by processes and timing.
Consider automation for helping with the service cost. Anyone not hiding beneath a rock knows that automation is changing how we do business. And in the financial-service business industry, automation continues to drive down costs, whether unit-cost per service or per product offered.
Innovations in automation have focused on reducing the cost of maintaining and serving customers. For example, just about all aspects of servicing customers has moved online, as well as to mobile. With what result? An increase in the productivity of small teams by enabling them to provide better service and to serve more customers per team member. Here at Factris too, we automate what can be automated so our team can give more focus on personal contact with our clients.
If your business is still primarily people-based, analyse what can be automated - but only if it’s worth the investment. In this case, the return on investment is often reallocating people to do things that they would enjoy more. A number of software as a service (SAAS) providers are making it easier to do business across a broad spectrum of industries.
Net Customer Profits
You’ve optimised your acquisition cost, and automation is helping with a large portion of your customer service cost. What now?
The most important variables left are:
- How long you maintain your customer relationship
- How often they use your service
- How much net revenue (the revenue left after subtracting the cost to provide and service your customer) you can generate.
Never forget: Your customers are your greatest assets. In order for your business to succeed, you need to focus on them and take the best possible care of them within a reasonable service cost.
Why are happy customers so important to a business?
- Happy customers provide referrals, which lowers the average acquisition cost.
- Happy customers do more business with you and generate more revenue.
- Most importantly, happy customers stick with you for a long time.
In a recurring revenue environment, there is a huge difference between the net present value of a customer over 12 months compared to over 48 months. You can gradually write off the acquisition cost over a long time and give yourself a much better return-per-customer.
In many industries, you can take averages to see over time how long customers stay. In our business, we have the benefit of certainty, with contracts of up to 48 months. These contracts enable us to pass on extra benefits to our customers - mostly in the form of discounts - to encourage customers to sign up for a longer-term.
Churn can kill
In a recurring revenue business, churn (the loss of customers using your services) can be toxic to the sustainability of your business. Consider: You’ve already incurred the cost of acquiring these lost customers, so their future profitability is quite high. In addition, you now have to pay to replace the churned customer and pay for another customer to keep the company growing. All of these negative effects of churn can kill the profitability of your business.
While some churn is unavoidable, you should actively manage the risk of losing your most coveted customers. So when calculating the cost to service, make sure there’s a provision for customer retention that’s focused on the high value of your existing customers.
Managing by measuring
Understanding customer lifetime value is crucial for entrepreneurs who are managing a business day to a day. So don’t delay in implementing it on the ground floor; make this a part of your business culture, so your company constantly measures and improves. Do so by setting up your key metrics once and then track them over time. Try to make improvements as you go along and see how they impact your financial performance.
The point of all of this careful analysis isn’t to stop dreaming; on the contrary - dream big! The future belongs to those who innovate and work hard to make a great idea happen. Just be sure that you have all of the financial pieces in place - especially the pieces that affect your customers, who are ultimately the ones that turn your dream into a reality.
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