Many businesses struggle to assign appropriate budget to customer acquisition and retention marketing.
Many businesses struggle to assign appropriate budget to customer acquisition and retention marketing. Time and time again I see businesses (re)allocate their budgets in favour of customer acquisition in an attempt to grow their database and revenue intake.
In this blog, I’ll help you understand the importance of customer lifetime value and the different metrics associated with it. By the end of this post, you will be able to make more informed, data driven decisions to help budget your marketing spend.
Why is Customer Lifetime Value important?
According to David Skok, the reason why many start-ups die is because their business model often looks like this:
An out of balance business model
What businesses tend to often do is focus on the actual average order value of the present customer as opposed to investing in what happens after the conversion. What does this mean? It’s not about tipping the scale in favour of the customer retention marketing strategy, it’s about having a balance in the business model.
Skok also points out in his article that this ultimately helps improve your customer lifetime value and places an emphasis on continuous optimisation.
You should always be investing to continually improving a product, however if we don’t focus on how to make our existing customers happy, the cost of acquiring a customer can greatly outweigh the amount we can make from an existing one.
The whole point to improving your customer lifetime value is to create this balance in your business model that will allow you to offset the unavoidable high cost factors within the business as seen below (marketing, low customer satisfaction, high churn rates).
What can drive the balance
Customer Acquisition Costs
If you’re familiar with PPC metrics then it’ll be a piece of cake finding your way around acquisition costs. To find your customer acquisition cost, we divide the total amount of marketing pounds by the amount of customers that come from those marketing efforts.
Cost per customer = marketing spend / number of customers
Similar to the PPC approach, we are able to break this down further by looking at:
- Cost of customer visits
- Cost of lead acquisition
- Cost of customer acquisition
In effect, this will give us a better idea of exactly where most of the spending is going. In a PPC scenario, if we saw the cost of customer acquisition is extremely high compared to the cost of lead acquisition, we can question whether the landing page is effective in relation to the keywords used and what users are doing on the page.
Using these values lets you explore new, less expensive avenues for acquisition and work on conversion optimisation.
Before calculating the lifetime value of your customers, it’s a good idea to see how long they will be your customers for. To calculate your customer retention rate, it’s advisable to grab a sample of customers (50 or more) and find out:
a Number of customers at the end of a period
b Number of new customers acquired in the period
c Number of customers at the start of a period
Customer Retention Rate = ((a-b)/c)*100
Bear in mind to get the best from this algorithm you should segment your customer database into groups to give you an insight as to which groups have a longer lifetime.
Calculating a Customer Lifetime Value
Throughout this article we’ve discussed the importance of Customer Lifetime Value, so you’ll also need to know how to calculate this metric.
Customer Lifetime Value = (Average number of Sale) * (Number of Repeat Transactions)
To get a complete and accurate picture of the data, you must segment your customer database. If this was a social mobile phone game, your customer segments would be (example):
- Those who buy extra equipment
- Those who buy additional items
- Those who do not buy
- Those who pay for a membership
Using this data you’re able to correlate with other gamers to see who tends to have a longer lifetime and those who churn quickly.
- Do those who have a membership buy additional items?
- Is there a relationship with those who’ve not got a membership but buy additional equipment?
- Do high churn customers buy any equipment or items?
Once a lifetime value of these customer segments are found, you will have a clear indicator of what types of customers bring the most value to your business. From this you can then make data driven decisions to strategise how much to invest in acquiring this type of customer or to increase lifetime value by cross and up-selling.