The Lifetime Value of a Customer as a Marketing Cost Guide

Marketing expenses are often looked at very narrowly: how much did I spend on a promotion, and how much did I make on the promotion? Minus out expenses, and you’ll have a very crude measure of how much return you received on your marketing investment. That narrow focus, however, will not give you a complete picture of your marketing costs.

I’ll give a few examples of how to use the lifetime value of a customer analysis to figure out the true value of marketing costs.

Let’s look at a new restaurant opening in town. They spent $5,000 on a combination of print and radio ads to promote their Grand Opening on a Saturday. Their revenue on Saturday is $6,000, of which 10% is profit, so they spent $5,000 to make $600. Ouch.

Now, let’s look at the same data and expand our analysis. Let’s stipulate that the average guest of a new restaurant spends $50 ($10 profit) and will return to the restaurant five times in the next year. Some will never return, and some will visit more frequently, but let’s assume five as an average. That means the value of a new customer is now $250 ($50 profit). If the restaurant adds 100 new customers due to the $5,000 ad spend, the gross sales added to a year’s revenue is $25,000 ($5,000 in profit). If we add a second year of 3 average visits, you’ll add another $15,000 to the top line (revenue) and $3,000 (profit) to the bottom.

Now, add the people that came before and after the grand opening because of the advertising, as well as the word-of-mouth recommendations from the people who ate at your restaurant, and you can see that the $5,000 ad spend might have been a great investment—if you look at the long-term value of customers.

One of our favorite analyses is to use pay-per-click data for advertising. Let’s look at tea subscription business. We’ll assume 50% margins on the tea.

We’ll go with $.50 per click for keywords related to your product. In my experience, you can expect about 1 in 25 or even 1 in 50 of the people who visit a good website to make a purchase. So, you’re looking at between $12.50 to $25.00 cost per sale. If your average sale is $40, you’d be looking at marketing costs between 31.25% and 62.5%, which means you would make almost nothing or lose money on each sale. Ouch!

But, let’s expand our analysis to look at the lifetime value of customers. For our sake, we’ll limit it to one year. If you have a Tea Society Club and 25% of your new customers purchase a subscription for a package a month at $40, you now have a value of each customer somewhere between $40 and $480 ($40/month for a year). Realistically, you’ll have many people stop their subscription, so go with half the total potential and assume $240, which would translate into $125 profit. Would you trade $25 for $125? Of course.

The 75% of the purchases that did not join the Tea Society are also worth something. Let’s say, on average, they order twice more a year—an additional $80 each, in addition to their first $40: $120, $60 profit. Again, $25 for $60 profit? Yes, in my book.

Unfortunately, many entrepreneurs look at advertising costs very narrowly; what did I spend, and what did I make at that time? That would be the right way to look at things if you are promoting a concert or a limited-availability product. That said, if you are trying to win new customers, especially if you have a consumable product, taking a broad approach to examining your marketing costs will help you make better decisions.

As a side note, any college student will tell you they are inundated with offers for credit cards. They might receive 5-10 solicitations a week. Why would a bank spend so much to win a customer with little credit history, few assets, and a limited income? The answer is simple: people seldom change credit cards, so the lifetime value of a credit card customer is huge. It’s very worthwhile to spend a lot on these young, future high-earning students.