Knowing the value of each customer is a crucial tidbit of information that every small business owner must be aware of to be successful. If you understand where your business stands in regards to each customers value, you can pinpoint ways to increase that value and your bottom line.
There are a few formulas designed to measure customer value, all of which may require the help of statisticians and finance experts to understand. However, for a small business looking to understand the value of their customers more clearly, they can break down the components of tools like the CLV and use that information to better target their customers. Here are 5 tips for understanding and increasing your customer value.
Your marginal profits are what you make on each transaction with a customer. This number should be calculated based on the total revenue brought in on a transaction, less the costs. For example, if you sell a muffin for $5.00 and the ingredients, labor and packaging cost $1.00, your marginal profit would be $4.00. If you add the total of your marginal profits in a set amount of time, and divide them by the amount of customers in that same set amount of time, you can get your average marginal profit per customer.
Is your average marginal profit meeting your goals? This is a fundamental element to a business’s success. Setting goals to increase the average profit per customer is an effective strategy with clear, scalable, action plan possibilities. You can easily see if you need to raise prices, include add on items or offer more high end items to increase that average.
To predict how long you will keep a customer, you can calculate your retention rate rather simply. You take the amount of customers you had at the beginning of 1 year and subtract the amount of those customers who left. Divide the end number by your starting number, and you get your retention rate for that year. For example, if you start with 100 customers and have 50 of those remaining, your retention rate is 50%. You can then calculate the lifetime of that customer by following this equation:
1/(1-retention rate)= customer lifetime.
In our example, the customers would then have an average life time of 2 years (1/(1-.50)). This can be calculated YOY to see the direction your customer loyalty.
This number is important for your business to evaluate if you are retaining customers as you should be. If not, you can investigate the reasons customers are leaving and create action plans to remove those elements. Consistently tracking your lifetime rate average can ensure progress.
When attempting to identify your most valuable customers, dividing customers into groups based on their common traits can be effective. While it is true that every customer is different, you can categorize customers effectively based on demographic, behavior, psychographic, gender, or what you see as the best category for your particular business. Customer segmentation is essential for a business in order to customize marketing strategies based on those groups which are bringing in the most profits.
One example is a business where the customers are grouped based on geographical location. There are 2 main groups, customers from the East and from the West. The business determined that although the Eastern customer’s group is just one-third of the total customers, 80% of the business profits came from the group. The West group on the other hand, is the largest portion of the total customers, but only provide 20% of the total profits of the business.
These estimates would tell you that the value is much higher for the East group than the West group, which means that the customers from the East should receive a higher percentage of the budget. This geographical segmentation can be even further broken up to better understand which areas are more profitable.
The broad approach to determine your average customer acquisition cost is to calculate your marketing costs for a given period, and divide it by the number of new clients you acquired in that same period. You want to ensure that the amount you spend per customer, is worth the amount you will earn from them in consideration of immediate and lifetime earnings. By analyzing your acquisition costs, you can ensure they are in line with your results.
It is equally important to focus on retaining existing customers. However, calculating the retention cost is a bit more complicated process, because there are a lot of hard and soft costs to include in the marketing cost total. How do you know that a cost is a retention cost? Ask yourself:
“Was the cost incurred in order to improve customer satisfaction or maintain customers?”
If the answer is YES, add it up.
This cost must also be examined to ensure that the amount invested, is increasing the average lifetime of customers. If not, it’s time to make some changes.
If you have a good understanding of how much you are making from each customer, how long you are keeping them and where they are purchasing most, you can more effectively make decisions to move your business in the right direction. These tips aim to highlight those areas you can examine within your business to increase customer value and in result, increase your bottom line.