This is probably the most important ratio for all businesses. And, believe it or not, when I ask business owners whether they exactly know how much they’re spending to convince a customer to buy their product or service, most of them (I mean almost all of them…) simply can’t answer.
Similarly most of the people who don’t know how much they spend per customer can’t tell you how much they get from a customer for the whole duration of their business relationship. This is terrible and probably one of the main reasons why we see so many businesses failing to develop a sustainable model and ultimately folding.
Before scaling any major advertising / PR efforts, you should calculate how much you might expect in sales from a single customer. I mean “net sales” after deducting the COGS (cost of goods sold), which include manufacturing (or purchase) costs but also the direct support / delivery efforts necessary to provide the product / service. You should also deduct your general expenses or at least factor in part of them in your calculation (since you can have different campaigns for different products / services, all attached to the same infrastructure, which will affect your LTV calculations).
Let’s imagine you can expect net proceeds of $3,000 from a customer between the moment he signs up and the moment he stops using your service (the gross revenues could be $6,000 or more, don’t forget to deduct VAT when applied). We will call this his CUSTOMER LIFETIME VALUE, or LTV. Let’s say that on average you will get $30 from this amount on a monthly basis, for 100 months, so approximately 9 years (that’s a long period but hey, you have an amazing product!).
Imagine you spend $300 to acquire the customer (paid advertising, marketing staff,…). It means that you will need 10 months to recoup your investment. That’s ok but be careful in terms of cashflow because you will usually have to settle the whole advertising budget during the first month, especially in the early days of your trading activity. So you must have enough cash to resist until the moment your investment pays off. Sometimes the ROI (return on investment) will require two or three years, even more in some cases. Many businesses collapse because they don’t have the cash to survive while the numbers are still in the red in their excel spreadsheet…
So keep on shipping with passion exciting products and services but don’t forget that business, at the end of the day, is all about numbers and especially about this very basic equation: customer acquisition cost vs customer lifetime value!