What Would You Pay For New Customers?
How much does it cost to get new customers? You probably make regular decisions about buying advertising and attending networking events. Today I share a tool to help make those decisions easier.
New Customers: How Much Are They Worth?
One of the first pieces of information to identify about your customers is their lifetime value to your business. The basic formula is simple – how much will customers spend with you and for how long? It’s best to calculate this based on margin rather than total spend to better understand the real value of the customer to your customer.
What is more complex is to calculate the soft factors to customer value. Will they make referrals? How profitable are they? They may be quiet steady customers that require little management or challenging customers that cost a lot to service. The detail of the formula is not too important – what is important is to start.
Action: Estimate the lifetime value of your average customer.
New Customers: How Much Does it Cost to Get Them?
The second piece of information you need is the acquisition cost of a new customer. To find this, you need to know the length of the sales cycle. Some businesses sell customers at the first call. Others take longer. In one business I own, a month is enough time to be sure that multiple prospects will go through a sales cycle. In another business of mine, we use 60 days.
Action: Once you know the sales cycle length, figure out how many customers you got in the last sales cycle.
You also need to know the advertising expense over the same period of time.
Action: Find the amount you spent on advertising during the last sales cycle.
Variation: Put a value on the time you spent networking or managing the sales cycle – this is a real expense but often not tracked by owners.
Now for the cool part – divide the advertising expense by the number of customers you gained. This is your cost per customer. Just knowing this number is fun to compare with other business owners. You can ask, “How much does it cost you to get another customer?” My experience is most don’t know. You now do. Very smart.
What can you do with this information?
It helps you to decide what is good advertising and what is risky. Before you buy any more advertising, you should estimate what you expect for new prospects and a close rate. This helps to decide if you should buy new advertising or do more of what is working. It helps me with vendor negotiations because I come from a position of information power. I share my acquisition cost with them and ask them to help me understand how their product/service is better. If possible, I try to get a commitment on the contract to that performance or at least a termination clause if their advertising doesn’t meet expectations.
New Customers: ROI for Acquisition
This is the bonus section. You already figured out the lifetime value of an average customer. You now know how much it costs to get a new customer. Have you ever wondered how long it takes to make a new customer profitable? The relationship needs to first pay back for the sales cycle investment, including advertising.
Action: Divide the acquisition cost by the lifetime value to get the payback period. Here’s an example: If a new customer costs $500 to acquire and is provides $3,000 in margin per year on average, the paypack period is $500/($3000/yr) or 1/6 years or 2 months. You are not profitable with this customer until month 3.
Take some time to find these numbers. It doesn’t have to be complex. You’ll want to have them in hand before the next salesperson hits you up to buy more advertising!