Customer Lifetime Value is one of those ubiquitous terms that’s often misunderstood. Simply put, your customer lifetime value is how much money a customer pays you over the course of your relationship with them. The goal is to turn one-time customers into a repeat customer, increasing the revenue that you generate from them. When you’re calculating your customer lifetime value, you’re often not looking to understand how much money that customer is bringing in, you’re trying to understand how much money you are spending to bring on and keep customers.
Knowing how much you’re spending to bring in new business goes beyond what you’re paying for a click or a conversion. Ideally, you’re collecting enough data to understanding how much you’re spending through each stage of the sales funnel.
Let’s start with the sales funnel. What is it? It’s the path your customer go through from stranger to customer. This goes by many names and forms, ex: customer journey, sales journey, buyers journey. For simplicity, we’ll use the straight forward upside down triangle with five stages: Audience, Prospect, Qualified Lead, Opportunity, Customer. When you visualize a sales funnel, the top should be the widest, that’s where you’re bringing in the most traffic. From there you winnow down in each stage as someone becomes more qualified, or closer to becoming a paying customer.
At the top of the funnel is your Audience. This should be the largest group since you’re casting the widest net to bring people in the door that could potentially be a good fit for you. This is where posting on social, writing content and speaking at conferences starts to make people aware of yo ur company.Technically, the stage above your audience are “strangers” or people who don’t know about you. Once they follow you on social, visit your website, or sign up to see you speak they become part of your audience.
Next are your Prospects. Typically these folks get into your funnel through filling out a form to download content, or signing up for your newsletter.
Next are your Qualified Leads. This is the group of prospects that start to have higher engagement. They might continually revisit your site, interact with you more on social media, or download multiple pieces of content. With this group, you’ll want to run some retargeting ads to continue to show them new content and keep them coming back.
The Opportunity stage is the group that raises their hands and says “I want to work with you, I want to buy your services”. They have engaged with you on a few different channels and now they are ready to have more serious conversations with you about your services. This group might get personalized emails or special offers.
Lastly, you have your Customers. These are the folks that buy something from you.
Now that you know what your sales funnel is comprised of, let’s figure out what you’re spending during each stage and how much your audience is worth.The goal is to spend less on acquiring new than the customer spends with you. For example, if you’re spending $5,000 to acquire a new prospect, but once converted to a customer that prospect only spends $3,000 on your services, you’re looking at a $2,000 deficit and you’ll never see a profit.
How do you compute your costs
This is what the general formula looks like:
Customer Lifetime Value (CLV) – Customer Acquisition Cost (CAC)= Net Customer Value (NCV)
Net Customer Value (NCV) x Opportunity Closing Rate (OCR) = Opportunity Value (OV)
Opportunity Value (OV) x Qualification Rate (QR) = Qualified Lead Value (QLV)
Qualified Lead Value (QLV) x Prospect Conversion Rate (PCR)= Prospect Value (PV)
Prospect Value (PV) x Audience Conversion Rate (ACR) = Audience Value (AV)
When people see a complicated formula they usually shut down. Or maybe that’s just me. However, if you know your metrics, this formula isn’t nearly as daunting as it looks.
Here are the figures you need to collect before getting started:
Customer Lifetime Value (CLV) – this is how much a customer spends with you for the duration of your relationship. For example, if your services cost $3,000 a month and you tend to sign on a customer for one annual contract, your CLV would be $36,000
Customer Acquisition Cost (CAC) – this is how much you spend on marketing to attract new customers, you can plug in your annual marketing budget for the calculation.
Opportunity Closing Rate (OCR) – If you talk to 100 people who have raised their hand to buy something but only 10 decide to to actually do it, that will give you your opportunity closing rate, which in this example would be 10%.
Qualification Rate (QR) – this is the percentage of people who transition prospect to a qualified lead.
Prospect Conversion Rate (PCR) – this is the rate of conversion from audience member to someone who is in your database.
Audience Conversion Rate (ACR) – this is the rate of conversion from strangers to your target audience. The industry standard is usually around .05, or 5%.
For easy math, let’s assume the following:
- CLV = $100,000
- CAC = $10,000
- OCR = 25%
- QR = 10%
- PCR = 25%
- ACR = 5%
This is what your formula would look like with your figures plugged in:
CLV – CAC = NCV
100,000 (CLV) – 10,000 (CAC) = 90,000
NCV – OCR = OV
90,000 (OV) – 0.25 (OCR) = 22,500 (OV)
OV x QR = QLV
22,500 (OV) x .10 (QR) = 2,250 (QLV)
QLV x PCR = PV
2,250 (QLV) x .25 (PCR) = 562.50 (PV)
PV x ACR = AV
562.50 (PV) x .05 (ACR) = 28.125 (AV)
What does this tell you? Each individual audience member is worth about $28. To improve your metrics, you would want to focus on improving your conversion rates between each stage.
For example, if your OCR rate increases from 25% to 50%, the value of an audience member would go from $28 to $56. This is important because the more valuable your audience is, the more potential revenue you can bring into your company. You should run this calculation at least once a quarter as your conversion rates fluctuate or as you evolve the services you offer. Knowing these figures will help make sure you’re not spending more than you’re making.
If you want help figuring out what your audience is worth, and your earning potential could be, let us know. We’re happy to help.