Use 'Customer Lifetime Value' to Evaluate Marketing Investments

by Tom Ruwitch

How much are you willing to spend on marketing to acquire a new customer? Most small businesses cannot answer that question easily, but all businesses would be stronger if they could.

To answer, you must consider how much value a customer brings to your business over the lifetime of the relationship.  Here’s a simple equation for this crucial data point, often called “customer lifetime value” (CLV):

(average revenue per sale) - (average cost for goods and services) X (average years of retention)

For example, an accounting firm may generate $1,000 per year in gross revenue from the average client. Costs of goods and services is $500, leaving $500 net revenue. The firm retains the average customer for nine years. So the average CLV would be $4,500 ($500 net revenue for nine years).

This is a rough calculation. There are other factors you can consider when calculating CLV, but for purposes of this discussion, the simple formula will suffice. Such simple calculations can help you determine a reasonable budget for your marketing.

I recently spoke with a small-business owner who balked at spending $250 per month on a new marketing program because it was “too expensive.”

I asked him how much he was willing to spend to acquire a new customer. His reply? “I’m not sure.”

Then we calculated the rough CLV for his business: $12,000/year, or $1,000/month.

Now the questions and answers were more clear.

Do you consider it likely that you’ll land at least one new customer if you invest in this program? How about two new customers? Three? Four?

He was confident that he could acquire at least two, and probably more, through this program.

So would you be willing to spend $250 per month to net a customer worth $1,000 per month or two new customers totaling $2,000 per month?  

It no longer seemed so expensive to him.

Of course, most businesses invest in multiple marketing channels, and it can be difficult to predict how many new customers your combined marketing activities may generate.

That’s why it’s so important to evaluate each channel separately and ask, “How likely is it that this channel will generate enough sales to offset the marketing spending?”

In the accounting firm’s case, it takes only one sale. In other businesses, you might have a lower CLV and need to generate more sales from a marketing program to profit.

Marketing is an investment. If you understand your CLV, you can more accurately predict the return on that investment. This will lead to more sales and a more profitable business.

Tom Ruwitch is founder and president of MarketVolt, a St. Louis-based marketing technology firm. Visit MarketVolt.com/resources for free downloads and webinars on a variety of topics, including How to Develop a Time-Saving, Business-Building Content Marketing Plan.