How to Use Customer Lifetime Value to improve your marketing
Effective marketing starts with asking good questions. Many times we are uncertain of what to ask or what metrics to look at to to get the answers we need to make sounds decisions in our marketing. Determining and reviewing your Customer Life Time Value is one of my favorite places to start.
If you want to know
- how much repeat business you can expect from your average customer,
- how much a new client is potentially worth to you,
- if you are spending too much or too little on marketing,
- if your product or service is scalable,
- how long before you are profitable,
…then you need to know your Customer Lifetime Value.
One of the most underrated metrics is customer lifetime value, often referred to as CLTV, CLV, LCV or LTV. No matter how you refer to it, this is one of the easiest metric to figure out and can provide a wealth of insight when combined with other metrics.
So How do you calculate customer lifetime value?
Note: it’s best if you can use information you’ve collected from real customers or clients.
If you know the amount of your average sale, how often a customer buys that product from you over a specific amount of time and how long they stay loyal to you before they move on, then you can quickly determine the LTV.
The equation looks like this: (average sale value) x (how often they purchase) x (how long they stay loyal)
Let me use a more specific example for a medical practice where the average patient visits 1 time per month for 12 months over a span of 7 years and each visit costs $50 plus the $150 from insurance.
$200 x 12 months x 7years = LTV
So if we stay in the context of a medical practice, we can automatically determine how much repeat business we can expect and how much a client is worth to our practice.
There are a few other cool things we can start asking once we have this information.
Is the retention period to short? If a patient’s average life span is 78 years, why are patients only staying with this practice for 7 years? Can we do anything to make it longer? Unless the practice a pediatric care or hospice care facility where patients naturally age out or near a military base where transfers are common; we may want to start evaluating our marketing efforts or even consider doing a survey on customer satisfaction.
So how do we determine if we are spending too much or too little on marketing using LTV?
In short you need to know your CAC or Customer Acquisition costs.
To learn how to calculate your CAC and other great metrics download this cheat sheet: 6 Marketing Metrics Your Boss Actually Cares About.
If your CAC is low, maybe around $1000 per customer, then you know that you will make a profit from that patient in the first year and you could likely increase your marketing spend to get new patients more quickly.
If your CAC was high, around $10,000 per customer, you would be able to determine that you are likely spending too much on marketing. It would take over 4 years to gain a profit from each patient.
Note: It may be that your overhead is too high.
How do we determine scalability and profitability with LTV?
Sorry, but this one’s not a simple formula, but if you can determine your CAC and your LTV, you can quickly get an idea of how scalable and profitable your business can be.
Since the CAC uses your overhead as a metric you can quickly gauge how long it will take to scale your business or reach a point of profitability. The only other metric you would need to know is your capacity for each month.
Continuing in the context of a medical practice, capacity is how many patients you can see per month. If you can see a maximum of 500 patients per month then you can likely assume that you will need to hire a second doctor to handle more patients per month.
You can also find out how much revenue you can produce in a month or over the span of a year. Subtract your monthly or annual CAC and you should be able to quickly view your profit margin.
If this medical practice is helping 400 patients per month ($80,000 in monthly revenue) it may be a good time to start considering hiring a new doctor. If you know how much you will pay that doctor, you can use your LTV and CAC to determine the best time to actually hire.
If they started out gaining 20 patients per month then you know it took 2-3 years to reach 400 patients per month and will potentially take just as long to hire another doctor.
Some other questions we can begin to ask once we understand our LTV are:
- Do we need to focus on marketing to existing clients more to improve our LTV?
- Would marketing other services increase our LTV?
- Can we increase the frequency of purchase in our LTV?
- How is our price affecting our LTV?
- How do we improve customer loyalty?
So take some time to figure out your LTV. Make sure that it measures up against your overhead and then start to ask questions about how to increase your LTV.I hope that you see how these numbers can affect your marketing decisions. Understanding the value of a client can help you improve your business all around.