In business, the most important metric is profit. Some companies tout revenue and total sales as vanity figures to show how successful they are.
You could easily have £2,000,000 in sales and £3,000,000 in costs. Now, the £2 million in sales doesn't look so impressive unless that company has substantial investment behind it or has made good profits in previous years to support lean years. That £2m revenue business isn't sustainable.
An underused yet incredibly useful business metric is Customer Lifetime Value. It can be used as a number to predict future investment, secure future investors, and understand the lay of the land for your business.
It’s used in just about all Software As A Service (SAAS) businesses, but more traditional everyday businesses should be using it too.
Calculating CLV
Straightforward to calculate, it goes something like this:
Average customer sale x Average number of purchases x Average customer length.
What you get in reality is what a customer is worth to you.
Example 1 - Coffee Shop
Let's say you run a coffee shop and the average sale is £7. An average customer comes in twice a week, and they are a customer for 6 years before moving to a competitor or moving out of the area.
£7 x 2 visits a week x 52 weeks x 6 years = £4,368
Not bad for a £7 cup that some businesses may put down as “comes in regularly.”
Example 2 - Cleaning business
A cleaning company has contracts with local businesses for maintaining their offices.
An average contract is worth £100 per week per office with 3 offices on average, and the average contract lasts 12 years, before either the business closes or they move to a competitor.
£125 x 3 office x 52 weeks x 12 = £234,000.
Useful metric?
I’m sure you can see how useful this metric is not only for Sass businesses but for any business. We have gone from a £7 increase in coffee to an income of over £ 4,000 per customer. If you were going to sell the coffee shop or looking for investment to expand, a bank or investor would find this information useful and pertinent in deciding whether to plough money into the business.
With the office example, we have gone from £125 per office to nearly a quarter of a million pounds. Armed with these important financial figures, the business has a much better gauge of how to spend on marketing. Spending £5,000 on a radio campaign or Pay-Per-Click budget online now looks like a fantastic spend if it got you just 2 new customers.
Profit
It comes back to what I talked about at the start of this journal entry; however, this figure does NOT take into account profit. That’s a different calculation. Remember, if your margins are low, this figure could well look insignificant compared to your business's profit.
CLV is a useful figure to calculate, though, and gives you a good idea of how much to spend on different marketing initiatives.
Written by John Macpherson