Chances are, you've heard radio advertisements touting fixed or variable annuities, Roth IRAs, and 401(k)s. If you live in the Chicago area, you may even have heard Mike Ditka on 890 AM-WLS promoting an indexed annuity product. Somehow I doubt that Da Coach, however strongly he may believe in indexed annuities, was working for free. Investment companies, it would seem, are willing to spend heavily to promote their services.
But how can these companies be sure their aggressive efforts will pay off? If an investment company spends $50,000 per month to keep its ad on the air, how many new customers will it have to attract to break even?
This question is pertinent to any company. Do you know how much an individual customer is worth to your business? In this post, I will outline some steps you can take to estimate the value of a customer.
First, consider sales made in the first year. Let's say a customer spends $100 on your products or services, generating $50 in profit. Anybody can calculate this.
Second, think about profit generated in future years. Let's assume there is a 90% chance the customer will buy from your company again in every subsequent year for 20 years. Let's discount future cash flows by 4% per year, an approximate rate at which you could borrow to invest in a new customer. The present value of that initial $100 sale carried out over 20 years would be $695 in sales, and $348 in profit.
Third, keep in mind that a new customer may increase the volume of his or her purchases at some point. He may do so by buying more of the same products or services – or buying other categories of products and services. Let's assume that after five years, the customer doubles his annual purchase to $200. The present value of sales would rise from $695 to $1,172, and profits would rise from $348 to $586.
Fourth, consider that one new customer often attracts additional new customers through testimonials and referrals. If each new customer refers a second new customer, the present value of the customer doubles to $1,172. What started as a $100 sale turns into a customer present value of over $1,000 in profits.
My assumptions – a 90% customer retention rate, a 100% increase in purchase size after five years, and a referral of a second customer – may seem a bit ambitious. But for some industries, these projections are reasonable. The point is, what are your parameters?
Recently, one of my clients in the investment industry calculated that a new $500,000 investor was worth a whopping $230,000 in net present value profits. That's enough to justify several radio advertisements—even with Da Coach.
So let me ask you again: do you know how much your customers are worth?