Customers are the most important assets in every business. This is why customer acquisition and retention are essential to the growth of an organization. However, with these individuals having a lot of choices to make from a number of vendors, it becomes hard to retain old customers and onboard new ones. In fact, an article published by the Harvard Business Review said that acquiring new customers costs 5-25 times as much as keeping old ones.
Clients want to have value for their money. According to Business Dictionary, customer value is the difference between what a customer gets from a product, and what he or she has to give in order to get it. So, for a customer to stick with your brand or decide to use it, they have to feel that you provide the best value among all the choices they have available. In a world of choice, value is subjective, and so, a number of factors are taken into consideration in various forms by different people.
For example, in Nigeria, when a person decides to use a mobile service provider, they have to make a decision between four main telcos and a host of smaller telecommunication firms. Prices of the sim card to most are insignificant when compared to the pricing of the data plan or the number of minutes a call would last when using that certain provider. In fact, some customers even make a choice based on what a large number of their friends or family members use (herd mentality). Others just make their choice based on certain data or call plans provided by the networks.
Now, once the customers have been able to determine that your business is the best choice for them, they will stick with you. However, it is also important for you, the entrepreneur to determine the value of that customer. It is illogical to spend more on customers who offer you less value than those who offer you more, be it in present or future gains. This is why it is important to know the value of your customers to prevent important ones from leaving and repositioning your finances to target those that provide the greatest benefits.
The key metric in measuring the value of a customer is referred to as Customer Lifetime Value (CLV). Hubspot defines it as “the metric that indicates the total revenue a business can reasonably expect from a single customer account. It considers a customer’s revenue value, and compares that number to the company’s predicted lifespan”. Basically, customer lifetime value is the total worth of the customer to the business throughout the period the individual or firm remains your customer. Knowing the CLV will help you improve your profit margins and ultimately drive growth.
To calculate the customer lifetime value:
1. Calculate the average purchase value:
This is done by dividing the total revenue in one year by the number of purchases made within that same year. So, as a restaurant owner, if a particular kind of customer, John, buys food 5 days a week from your restaurant at a constant price of N600, in a year, that customer would have made you N144,000. The customer has also purchased food 240 times (5 days/week x 4 weeks/month x 12 months/year). Hence, the average purchase value is N600. Once you do that for one customer, you can do it for say, ten more, and just get the average of all of them.
2. Calculate the average purchase frequency rate (PFR):
This is done by dividing the number of purchases over the time period by the unique customers who made purchases during that time period. If you are a restaurant owner, customers may come once a day to eat or twice. However, sometimes, they may decide to eat somewhere else or may get stuck in traffic and not eat at your restaurant. In such a case, you calculate how many times John visits your shop in a year and divide it by the number of people you are surveying (i.e. 1 person). So, since it is only one kind of customer you are measuring and he visited 240 times a year, the average PFR is 240.
3. Calculate customer value:
Here, you simply multiply the average purchase value and average purchase frequency rate. So, for John, his value to your business yearly is N144,000.
4. Calculate the average customer lifespan:
This is done by finding the average of the number of years a customer purchases a product/service from you. So, if you are selling near an office, there is a high possibility that the average customer lifespan could be 3. That means after 3 years, such customer, like John, would stop buying from you- most likely because he got fired or got a new job elsewhere. If you sell close to a residential area, the average customer lifespan could be up to 5.
5. Calculate the customer lifetime value:
Assuming John buys from you during his lunchtime at work every day, the lifespan is taken to be 3 years. Multiply the average customer lifespan with the average customer value. For John, it would be N144,000 multiplied by 3, giving you N432,000. Thus, for the 3 years, John would be with you, he would give you N432,000.
Once you are able to segment customers into Johns or Emekas or Wunmis, you would be able to get a sense of the value of these categories of customers. To take it further, you would be able to predict which customers you should focus on marketing to frequently and which you should focus on simply keeping happy because as posited above, customers differ. Some buy in bulk and others are frequent low-cost buyers. So, for the restaurant owner in the example above, it would not make sense to heavily spend on marketing on John. Nonetheless, if there was a Wunmi who bought only twice a month but bought for her entire staff of 30 people, it is vital to keep such customer very happy, since it is easier for that person to stop buying from you, given their low average purchase frequency rate. Remember, if the cost of serving such customer exceeds the benefits gotten, you may be making a loss, so it is also important to learn how to balance your strategies.