It's clear that keeping customers brings tremendous value to the firm.
But how much?
There are myriad ways to calculate the lifetime value of a customer to the firm. No matter the measure, producing a concrete dollar figure gives management a tangible pivot point around which to design customer retention strategies.
Below is a simple calculation your firm can use to calculate the lifetime value of a customer.
THE VARIABLES
Below are defined variables that go into the lifetime-value-of-the-customer calculation. Don't be put off by the letters; they're merely a simple way of defining which numbers to insert where.
S = The average amount of money a customer spends per visit to your firm.
C = The average costs of servicing the customer per visit.
V = The customer's expected number of visits per year
Y = The expected number of years the customer will use your services
A = The costs of acquiring a new customer.
N = The number of new accounts the customer refers to you
F = The correction factor for the time period analyzed. The correction factor captures changes in a customer's behavior over time. If you estimate that the customer will increase their money spent per visit over time over time (because you estimate you will increase their loyalty), then put in a higher number - say, 1.4. If you estimate the customer will decrease their spending over time, put in a lower number - say .9). This is a subjective estimate.
SIMPLE CALCULATIONS
Before we get to the total equation for figuring the lifetime value of a customer, we can gain a lot of information from some simple preliminary equations.
S-C = The average revenue generated by the customer per visit.
VxY = Total number of visits over the customer's lifetime
AxN = The amount of money saved by the customer's referral
The Lifetime Value of the Customer
If we put these simple equations together, we can determine the lifetime value of the customers.
Lifetime Value of the Customer = [(S - C) x (V x Y) - A + (A x N)] x F
AN EXAMPLE
We can see the true value of this equation with an example.
Average amount of money spent per visit: $50
Average costs of servicing the customer per visit: $4
The customer's expected number of visits per year: 24
Expected number of years for the customer's patronage: 40
Costs of acquiring a new customer: $15
The number of new accounts the customer refers to you: 4
Correction factor for the time period analyzed: 1.1
We plug these values into the equation and get the following:
[($50 - $4) x (24 x 40) -$15 + ($15 x 4)] x 1.1 = $48,626
CONCLUSION
This number represents a relatively accurate estimation of your customer's value to your firm over the course of the customer's lifetime. When designing long-term strategies, or assessing the cost of losing customers, this equation can provide a sobering illustration of the results of your efforts. In this way, you can better guide your firm toward the kind of success it desires.
