Lifetime Value of a Customer, Part 2

In a previous blog post, the ratio Lifetime Value of a Customer against Cost of Acquisition was introduced. The concept effectively promoted the idea that the Gross Margin of new customers should be considered and studied relative to the cost of acquiring those customers.

Such analysis can take a business in several different productive directions. Trend analysis can help a business understand the effectiveness of their marketing and sales activities. Benchmarking this ratio against industry norms will aid a business in understanding their effectiveness in reaching customers specific to their industry. Ratio analysis can assist a business in understanding if sales activities are yielding high value customers that are retained over a prolonged period of time.

Not addressed in previous blog posts was the consideration of how quickly a business recovers the cost to acquire a new customer. How quickly a business is able to recover the Cost to Acquire a customer is a critical factor on the business cash flows.

As a reminder, use the contributory margin to calculate the Lifetime Value of Customer. The concept of focusing on contributory margin enables a business to highlight two key issues: 1.) Fulfillment related challenges are isolated in a business’ margin analysis and does not “confuse” analysis regarding the effectiveness of business development activities. 2.) Whether or not the business development activities are yielding high-value customers. For example, discounting price points will decrease the contributory margin and result in a decreased Lifetime Value of a Customer as well as length the time required to recapture the cost to acquire a new customer.

Understanding and appreciating those points, it is equally critical to understand how quickly the Cost to acquire a customer is realized by a business. This time period is important to review and understand relative to the estimated lifetime of a customer but at a minimum, it should be less than a year. Shortening the length of time required to recapture the cost to acquire a customer demonstrates positive progress within a company’s business development activities and operations.

It is also critical to understand the impact that this metric has on cash flows. The longer the time it takes to recapture the cost to acquire a new customer, the larger the drain on cash flows in the business. The same way that businesses review pay cycle and collections cycles, this metric can be used to understand the total cash cycle of a business.

These concepts can be confusing and difficult to calculate. We can help. If you need to understand the cost to acquire a customer and contributory margin, call TGG Accounting today.

Written by:
Andrew Ruff
TGG Accounting
 
 
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