Your customers are the reason why your company exists. Without customers, without addressing their needs, you don’t have a business.

But customers are rather hard to get, and expensive. If you deliver commodity products that everyone needs, you’ve got plenty of competition and margins are razor thin. If you instead focus on specialty services needed by few customers, your difficulty is finding and engaging those people.

In either case, it’s critical to keep those customers, purchase after purchase, contract after contract, and to help them to recommend you to their family, friends, and colleagues.

We all know this. But how much is enough? Should you spare no expense to retain even the most difficult clients?

This is why we explore the concept of the lifetime value of a customer.

Return on investment

Like any assessment of value, we’ll look at two elements: The investment you have to make, and the return that you get because of that investment.

  • Costs. Let’s start with the obvious ones: The materials and labor that it takes to deliver your product or service. Next, we add the expense of acquiring that customer. Finally, it takes some effort and perhaps tangible cost to retain the customer, to keep him or her satisfied and motivated to return for another purchase.Many people just include the cost of retention along with the general marketing costs. There are two reasons to split this out separately. First, it will help to highlight some extra things you should be doing specifically to retain customers. Second, it reinforces to you and your leadership team that it’s usually far easier, and cheaper, to retain satisfied customers than to go out and acquire new ones. You need a balance of both, of course.
  • Return. There are two primary forms of the return you get from this investment. First, look at the revenue you’ll get from every purchase the customer ever makes. Second, count the influence that the customer has on helping to build your future clientele.

Lifetime value

A few questions arise when you start analyzing the lifetime value of your customers:

  • How much marketing cost should I allocate? Ideally you’ll capture at least 80 percent of your marketing expenses, enough to help you make the most important tradeoffs. I recommend you start by dividing your general marketing budget by the number of customers you’re serving. If you have different marketing investments for different target market segments, then you can compute this ratio for each type of client you serve.
  • How do I know the referrals and recommendations my customers are making? The easiest way is to ask each new customer how they found out about you. It’s not perfect, and you may not always be able to get the specific name of the referrer. Even without that, you can still judge the degree to which your customer satisfaction efforts are working, and the ratio of customer acquisition due to your own efforts versus other indirect methods.
  • What do I do if the expenses outweigh the revenue in this calculation? This is going to be quite common, especially in the early days of a customer relationship. Often it costs far more to acquire a new customer than she might spend on the first few purchases. This is exactly the point of the exercise. Repeat business and referrals dramatically reduce your cost of customer acquisition.

Realize that sometimes you’ll never reap your investment in acquiring a particular customer. Some customers are a drain on your organization, never yielding any profit. In this case, you may want to make decisions around these questions:

  • Is this customer yielding other value, such as referrals, strategic relationships, or improved visibility in the market?
  • Is this just the price of reaching the customers who do yield significant profit?
  • Is it possible to let this customer go without negatively impacting your business or other customers?

Spend some time to look for the win-win balance between you and your customers. When you both receive value, you’ll have the basis for a strong, sustainable relationship.

Carl Dierschow is a Small Fish Business Coach based in Fort Collins. His website is www.smallfish.us.

Copyright © 2011 Northern Colorado Business Report by Biz West Media.
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