Calculating the Lifetime Value of a Customer

By April 22, 2014Customers
"Customer lifetime value" on chalkboard

 
Without customers, businesses fail. This is why they’re the primary focus of any company, because without them no business could continue to exist. This concept is pretty much common knowledge. However, something that many people don’t understand is the lifetime value of a customer. Most organizations see the instant benefits of new clients, but may fail to grasp their lifetime values.

Today I would like to walk you through the process of calculating the lifetime value of a new customer. First we will look at all of the components we need to consider, and then how to calculate the actual value.

Here are the components that go into a customer’s lifetime value:

  • Average Purchase per Recurring Customer
    
This is the average dollar amount of a purchase made by a customer throughout his relationship with your business. For example, a monthly service fee of $10 or an appointment fee of $40.
  • Average Number of Purchases Over Lifetime
    

This is simply the average number of purchases that your customers make while they maintain a relationship with your business.
  • Average Revenue per One-Time Customer
    

This is the average dollar amount of a purchase that is typically one-time. These customers make a one-time purchase and probably won’t buy from you again.
  • Percentage of Your Customers/Clients That are Single Purchase
    

This number simply identifies what percentage of your clients are “single-purchase” customers. It is probable that this figure will be 100% or 0%—depending on the type of business. Some companies have both recurring and one-time customers.
  • Gross Margin of Client
    

This is the percentage of revenue gained from a client that will be above cost (profit percentage). This can be difficult to calculate as well, but it is well worth the effort to establish what kind of profit percentage your business gets from the average customer.

The first step in calculating the lifetime value of a new customer is to determine each of the above. This could be simple or very difficult depending on how well you track data. Keep in mind it is always helpful to record customer data for business management.

Once you have identified these values, all that is left is some simple math. Here is the equation you can use to calculate the average lifetime value of a customer:

  • Calculate Average Revenue per Recurring Customer
    

Average purchase per recurring customer X average number of purchases over lifetime = average revenue per recurring customer

  • Calculate Total Average Revenue per Customer

    
Average revenue per recurring customer X ([100%—or percentage of your customers/clients that are single purchase] + [(average revenue per one-time customer X percentage of your customers/clients that are single purchase]) = average revenue per customer

  • Determine Average Lifetime Value per Customer
    

Average revenue per customer X gross margin of client (%) = average lifetime value per customer

 
That’s it! Now you know the average lifetime value of a new customer. Be sure to keep that in mind when building your marketing budget. While marketing may seem expensive in the short term, it is important to remember just how valuable every new client is to your business.

Take the time to figure out what just one new customer is worth to your business. You’ll be glad you did.