Data offers companies an unparalleled opportunity to win more customers, but with an ever-increasing quantity of what’s trackable, how can companies use it effectively?
How many customers do you have today? What is a customer worth to you? If you could buy a customer off the shelf, how much would you be prepared to pay? The ability to answer these questions accurately creates a golden opportunity: if you understand both the lifetime value of your customers and the cost of acquiring them, you can set your business on the path to maximising profit.
To begin that journey, we believe it is crucial to think about your marketing function in a new way. Rather than just another department with a budget to spend, marketing should be at the commercial heart of your business; it should be a profit centre rather than a cost centre, driving a customer acquisition engine that generates continuous growth.
To achieve that goal, marketing needs to step up its measurement – the more accurate and comprehensive your data is, the smarter the decisions you’ll make on the basis of it. Assessing customer acquisition cost vs lifetime value isn’t straightforward, but the better you get at it, the more your results will improve.
Calculating customer lifetime value and acquisition cost
What is customer lifetime value?
Customer lifetime value tells you what a customer is worth to you over the time you retain them: it’s the revenue generated by the first purchase they make with you and all subsequent purchases, less any variable costs associated with serving that customer, such as payment charges, customer support costs, or cost of goods.
What is customer acquisition cost?
Customer acquisition cost is what it costs you to get that customer on board: what you spend on advertising, as well as all the other costs you incurred, from agency fees to the cost of your sales team.
With the use of these two indicators you can work out how to grow your business profitably by investing in your marketing activity to acquire more customers at a higher average customer acquisition cost. And the more nuanced you can be with this analysis, the more success you’ll have.
Too often, businesses think only in terms of revenue, forgetting about some or all of the costs of acquisition – particularly the less obvious costs like the cost of a sales team. They also tend to neglect the cost of serving the customer – the cost of sourcing the goods they buy or providing the service they pay for, as well as other costs; these include everything from maintaining a customer warehouse to handling customer calls.
You’ll also need to make some judgements about behaviour. For example, you’ll need to unpick the repeat purchases from customers that happened because they became loyal following the first purchase, from those that happen because you’re still advertising. If you’re an online travel brand, say, and you acquired a customer through paid search, if the customer books again a year later because you’re still advertising on the same terms, that’s not really loyal behaviour; it should still be part of your lifetime value calculation but it needs to reflect the cost of getting the customer to return.
A new customer acquisition and retention strategy
Naturally, the profile of your lifetime value will vary according to the nature of your business. If, say, you’re a software business with a software-as-a-service (SaaS) model generating recurring revenues, you’ll see more of a straight line over time; if you’re a retail business, it will look lumpier as you complete individual transactions.
Either way, as you’re thinking about targeting new customers, your measurements should give you a more informed basis on which to proceed. The cost of customer acquisition varies, and the returns diminish as you have to spend more; but with the right data, you’ll have a clear picture of the total profit you’ll make for any combination of cost of acquisition against lifetime value.
Even better, you can improve the dynamics of this equation. First, it’s possible to do things to make your marketing more efficient: for example, you could invest in a new website to improve conversion rates or redesign sales processes to convert more customers. In doing so, you’ll increase profit without having to spend any more on marketing at all because you can reinvest savings in acquiring more customers.
Second, you can improve the lifetime value of your customers by targeting the most valuable segments. Once you’ve worked out which customers derive the most value from your products or services, you’ll know which customers you should be going after.
Bringing it all together
Crucially, this isn’t a one-off exercise: when your marketing team constantly repeats and refines this analysis, it can create a virtuous circle of customer acquisition. That’s what we mean by building a customer acquisition engine.
Livingbridge investee company BoilerJuice is one example of a company that has done this very successfully. We’ve worked with BoilerJuice, the leading online heating oil marketplace, to calculate the true lifetime value of their customers and how much are they prepared to spend on marketing. Roughly speaking, the spread between the lifetime value of a customer today and the cost of acquiring that customer is more than six times. That is an opportunity to accelerate the rate of customer acquisition, invest more in marketing, acquire more customers overall and ultimately drive profitability.
As for your business, if it is not at this stage yet, don’t panic – you’re not alone. Livingbridge research suggests fewer than one in three marketing leaders in small and medium enterprises have a good understanding of the lifetime value of their customers in terms of profit. Another third or so have an understanding at a revenue level, but many have no data at all.
We believe rectifying this can be one of the most impactful things any business can do. If you’re still thinking about marketing as a cost centre, there’s a good chance you’re underspending on this function – and missing an opportunity for marketing to drive growth. Now is the time to make the leap.
We are always interested to meet with business owners and managers thinking about building a customer acquisition and customer retention strategy– if this is you, we would love to talk! Please get in touch on investments@livingbridge.com to arrange a meeting.
