Calculate Your Customers' Real Worth
November 10, 2011
Doing the Math
When you measure the results of your ads, it's not enough to simply count the number of people who respond, or even the customers who buy something. What you really need to know is the future value of each new customer.
That information can be found by figuring out a customer's marginal net worth. Despite the simplicity of calculating this figure and the benefits of knowing it, barely one in 1,000 businesses thinks in terms of a customer's actual value to their bottom line.
There are actually two figures you need to determine: The net marketing profit and the customer's marginal net worth. It's an easy two-step calculation.
Let's say you pay $4,000 for an ad and 100 people respond. Of the respondents, 20 actually make a purchase.
Step One: Assume the 20 customers spend an average of $450 each. Subtract production and distribution costs of $240 and your gross profit on each sale is $210, or a total of $4,200 (20 times $210). Divide the cost of the ad by your 20 new customers and you see that each of them cost you $20 to acquire. Now, subtract the $4,000 ad from the $4,200 gross profit and you have net marketing profit of $200.
That may not sound like much, but look farther ahead.
Step Two: Let's say that on average, each new customer makes three purchases over the next two years and the average gross profit on each sale is $300. Calculate $300 times three purchases times 20 customers and you wind up with a gross profit of $18,000. Each customer that cost you $20 to acquire, brings in $10 gross profit initially and $900 later. This is the customer's marginal net worth.
This data is invaluable for these reasons.
Smarter ad spending. You can justify spending more to win customers when you know that each will ultimately bring in $900 in gross profit. You can spend as much as $100 to bring in each new customer and still keep $800. And the higher outlay has the possibility of generating more new customers.
Better cash flow tracking. You can estimate your future cash flow with some certainty. You know that whenever you run a similar $4,000 ad, you'll probably generate about $18,000 in gross profit over the subsequent two years.
Making your business more attractive. If you want to sell your business, show a prospective buyer a projection of customers' marginal net worth. The data can go a long way toward closing a sale.
So isn't it time you started thinking long-range and seeing what each of your customers brings to the bottom line?
Walking a Tight Rope Without a Net
Understanding your prospective customers' marginal net worth lets you determine how much to spend to win their business. It also helps you reliably predict cash flow.
Don't underestimate the value of a careful cash flow projection. It facilitates planning decisions, allows you to prepare for downturns, and makes you aware of when to borrow.
Prospective lenders want a professionally prepared cash flow projection and knowing your customers' marginal net worth is a key part of this calculation.
Take time to run the numbers, or ask your accountant to do it for you. It can put your business head and shoulders above the competition.