Determining Customer Lifetime Value for Your Internet Marketing Plan

About a year ago my college age daughter joined a CD club at Columbia House, attracted by their 12 CDs for 1 cent offer. She had to agree to purchase a minimum of six CDs at regular price within two years. She's already completed her initial minimum and has spent about $200 with a year to go. I would guess that she's not untypical.

Can you imagine how radical it was the first time a Marketing Director proposed such a huge kind of giveaway to the CEO:

"You're going to give away that much product for free?" shouts the CEO, now on his feet. "That's outrageous! That would cost us at least $25.00 per customer."

"$27.32, actually, sir, including shipping and handling," recites the Marketing Director timidly.

"How do we know they won't just take it and run, and never buy a thing more from us?" blusters the CEO.

"Experience, sir. We've calculated our average Customer Lifetime Value of our existing customers," replies the Marketing Director, trying to keep his cool, "and it's $100 over two years. We'll lose some money the first year, but gain it back as that customer continues to purchase from us. In fact, sir," he continues, feeling more confident as he goes, "this plan will gain us four times as many customers as our former marketing plan, and by the second year begin to increase revenue by 60%." (Note: these figures are merely for sake of example, and do not represent any particular business.)

How to Determine the Customer Lifetime Value

Now don't get me wrong. I'm not suggesting that you suddenly give away products. But I am proposing that you determine the Customer Lifetime Value for your own business, as accurately as possible. This is how you determine it:

1. Compute your average profit per sale (total sales revenue minus advertising, marketing, and product or service fulfillment expenses, divided by number of sales)
2. Determine how many times the average customer will purchase from you, say over a two year period.
3. Calculate the amount of profit you make from that customer in two years.

Actually, the number you come up with will be high, since it includes all the advertising expenses necessary to stimulate sales from new and existing customers, and getting that first purchase is the most expensive. After that your customer is inclined to purchase from you, and once you have an address you can target-market to her much less expensively than to the general public. Your existing customers also generate new customers from their referrals. If there's a way to quantify all this it gives you valuable information.

However, you can make some estimates. The Ryan and Wong Consulting Group, Inc. has a JavaScript calculator on their website you can use to make these computations. http://www.ryan-and-wong.com/lvalue.htm The more accurate the data you input, the more reliable the result. Unfortunately, there's no easy way to accurately predict the Customer Lifetime Value for a start-up. You'll need to start with some educated guesses based on careful research and the experience of others.

What It Tells You

Why is this so important? Because if you know that each customer will bring you $38 profit over a two year period, then you can afford to break even or even lose money on the first sale in order to acquire the customer, since you know that on average you'll make it up later.

Marketing wizard Jay Abraham puts it this way in his new book Getting Everything You Can Out of All You've Got: "Until you identify and understand exactly how much combined profit a client represents to your business for the life of that relationship, you can't begin to know how much time, effort, and, most importantly, expense you can afford to invest to acquire that client in the first place."

Once you know your Customer Lifetime Value, you'll know how much you can afford to spend -- or lose -- to get that first sale. And that knowledge is priceless. I'm convinced that this one single fact -- the lifetime value of your customer -- is absolutely vital to an intelligent marketing campaign. Without this knowledge, you're shooting in the dark; with this knowledge you'll be willing to take the short term risks necessary to in order to achieve long-term gain.

Exercise: Estimate your own online business's Customer Lifetime Value. The results a sure to help you look at your marketing plan more realistically.