This literally can be the most profitable thing you’ll ever do for your business and that is to understand exploiting the actual value of your customer. It’s been called the Marginal Net Worth and the Lifetime Value.
What is the current worth of one of your customers or prospects? It’s the total profit of an average customer over the lifetime that they do business with you. That includes all subsequent sales minus advertising/marketing and your fulfillment expenses.
Let’s say the average customer brings you $75 per sale. They re-purchase 3 more times in a year. Their average order amount is $300. On each $300 reorder, you make $150 gross profit. The average life lasts 2 years. Every new customer is worth $975.
You reach the $975 by adding the $75 initial profit to the 3 other purchases each year of $300. Only $150 is profit, so $150 times 3 equals $450. If they do that for 2 straight years, that’s $900 plus the original $75.
If this is our average customer and they’re worth $975 in profit and it only costs you $30 through your advertising/marketing expenses to get them, every time you spend $30 you receive $975 back.
You would be foolish not to increase your advertising/marketing and promotional budget to produce as many of these $30-cost customers so you would spend $30 over and over and over again to get $975 back for each one.
Theoretically, you could spend $975 to get that customer because you know they will come back and spend $975 and you will break-even. Of course, we don’t want to do this. Remember, this is an average customer. Some will buy more and some will buy less. This is an average number.
Now you know you can spend up to $975. You could just as easily be spending 100% of your $75 profit just to get that first sale because that’s just the first sale’s profit, so you’ll still end up with $975 over the next 2 years.
If you offered to give that $75 service for free and it doubles your customers, it would double your profits over the next 2 years.
One in 100 business owners think about this. You want to spend everything you can justify to bring in a customer as long as that customer costs you less than they earn you. If you can’t afford to spend more than the entire profit from the first sale, remember you’ll be making money just in a few months from them. Start out spending what your cash flow can justify. After a quarter or several months after their re-order profits come in, then you can step up your ad budget.
Another advantage is that most competitors have no idea what their customer is worth. If their marketing budget is a percentage of their sales, during a recession they might cut their ad budget. If you continue advertising and marketing at your current level, you’ll get their customers.
If you haven’t calculated your customer’s worth, here’s how you do it:
- Compute your average sale and your profit per that sale.
- Compute how much additional profit a customer is worth to you by determining how many times they come back and buy. Be conservative.
- Figure out precisely what a customer costs by dividing your marketing budget by the number of customers it produces. If you spend $1,000 on marketing and you get 1,000 customers, they’re costing you $1 a piece. Prospects are the same. Maybe out of that $1,000 you get 10,000 prospects for $.10.
- Compute how many sales you get for so many prospects; the percentage of prospects that actually become customers. This will be your “Closing Ratio.”? If you get 10,000 prospects and you have 1,000 customers, that’s a 10% Closing Ratio.
- The Marginal Net Worth of a customer is computed by subtracting the cost to produce that customer from the profit you expect to earn from them over their lifetime.
Ultimately, we want you to spend less and less getting the customers in other words, your Acquisition Cost?but this method is a way to generate customers short-term. If you were to go out and do business for free on that front-end sale, you’d be getting customers left and right. Eventually, you want to cut back on that and slash how much it cost to get them.
Everybody wants as many new customers as they can get, but nobody really knows how much a customer is worth so they don’t know how much they can spend to get one.