Determining Customer Lifetime Value:

How Fewer Customers Can Mean More

Profit

Imagine waking up tomorrow, with an inbox stuffed full

of emails from half of your customers letting you
know they’re never going to purchase from you again.
Sounds like a disaster, right?
Now what if I told you that losing 50% of your
customers would only reduce your revenue by 10%,
and by the end of the year you would actually be
making more money than before because you had
been able to reduce customer support hours by 75%.
Probable? No.
Possible. Very much so.
It’s a scenario that I’ve seen myself. After running the
numbers for one of my clients, we realized that the
bottom 50% of their customers were accounting for
about 10% of their revenue, while causing the vast
majority of their customer service issues.
If the bottom half of their customers never purchased
from them again, they would only lose 10% of their
revenue, but it would allow them to pare down their
customer support staff enough that their business
would be better off.
 While this is an extreme example of what can happen
when you calculate out the value of your customers,
similar results are not uncommon.
Calculating The Lifetime Value Of A Customer
If you do only one thing over the next month to help with marketing,
please make it this. I can’t think of a more important place to start
improving your marketing than determining how much a customer is
worth to you.
After I go through this today, I’m going to ask only one thing of you,
and that’s to make some time in your schedule to make this
calculation.
I’m going to break this down for you as simple as I can, because I
feel it’s a daunting task for many businesses, when it shouldn’t be!
It’s not terribly complicated, and anyone with a little experience and
access to the right numbers should be able to do it.
(If you are told that it’s more complicated than this, beware,
because it probably means someone is trying to sell you
something.)
I’m going to cover 4 main questions that come up when exploring
this topic.

1. Why is calculating the LTV of a Customer Important?

2. How Do I Calculate the Lifetime Value of A Customer

3. What if my businesses just got started?

4. What should I do with the information after I learn it?

Why Calculating The Lifetime Value Of A Customer Is

Important
In the hands of a creative business person, I can think of few things
more important than determining what a customer is worth to an
organization over their business lifetime.
It’s so important because it will provide you with an idea of what you
can spend to acquire a new customer.

This hilarious referral program set up by VinoMofos.com nails it.

They are willing to pay $25 for a new customer, because they know
that $25 will come back to them in the future.
Here’s a little secret….

Not Every Customer Is Created Equal

You didn’t think they were, did you?
Ryan Kelly from Pear Metrics does a great job of illustrating this in
his post The Importance of Lifetime Value in Marketing
Another mistake marketers make is assuming that all of your
customers are exactly the same in terms of revenue per customer,
cost per acquisition and other metrics. This is wrong. Let me
illustrate:

For many, the majority of their customers are going to fall in the
middle of being fairly active and profitable customers, while about
20% are relatively inactive (or customers who use up a lot of
support, rarely upgrade or buy peripheral products), and another
20% who are highly active. The 20% of highly active customers are
really your “brand evangelists”. These are folks who refer a lot of
new customers, upgrade frequently, and generally purchase on any
cross-sell opportunity because they truly love your product or
service.
In every instance of calculating out lifetime value, my clients have
found they are spending more time and money on customers that
are worth nothing too them, and not enough to get the customers
that really count.
Ok, so….
 How Do I Calculate The Lifetime Value Of A
Customer?
Calculating the LTV (that’s what I’m going to call it because Lifetime
Value is WAY too long for me) is not something you are going to be
able to find in Google Analytics, but it also doesn’t take extensive
math.

The Basic Version

Lifetime Value (LTV) = Total Customer Revenue – Total Customer
Costs
Which means all we need to do is find the Total Customer
Revenue, then subtract the customer costs.

1. Average Purchase

2. Average Number of Purchases per Year

3. Average Cost of a Customer (this is usually the most difficult one to

find)
I’ve found the best way to learn is to watch someone else do it first,
then try to parallel their business to your own.

Neil Patel, and his team over at Kiss Metrics have put together a
fantastic case study about how Starbucks calculates its lifetime
value of a customer.
Before you click let’s make this more fun, put a number in your
head that you think is reasonable for how much the average
customer spends at Starbucks over their lifetime.)
Now let’s walk through this Fantastic Lifetime Value Resource