ATTENTION: Lawyers, accountants, architects, creative agencies, recruiters, financial planners, consultants…any other business in the business of ‘buying and selling’ time…
…this applies to you.
Some seasoned entrepreneurs may say revenue growth, profitability, lock up – amongst others – are the most important metrics to your business. Of course they are important, however I believe one significant metric is often missed, even though it’s one of the most simple.
CUSTOMER LIFETIME VALUE (“CLV”)
What is it?
CLV is a prediction of the net profit attributed to the entire future relationship with a customer. The prediction model can have varying levels of sophistication and accuracy, ranging from ‘have a guess’ (low cost and rubbery) to the use of complex predictive analytics techniques (higher cost and still rubbery)
Let’s go the low cost and low complexity model.
I charge my client Bob the Builder $7,000 per annum for bookkeeping services. At a 50% gross profit margin, he is worth to me $3,500 in annual gross profit. I have a fairly good relationship with Bob (he’s my next door neighbour) so I estimate there’s an 80% chance he’ll continue using me into the future.
CLV = $3,500 * [0.80 / (1 + 0.15 – 0.80)]
CLV = $8,000
Why is it important?
Tracking your CLV has a swag of benefits, but here’s a summary of what I think are the most valuable:
- It can assist with ranking your clients
By placing CLVs on each client in your portfolio, you can quickly rank your client base and assess which clients you should be investing most time in.
For example, Client B may not be as profitable as Client A based on current year values, however over a lifetime value basis, Client B is actually more valuable to your firm.
2. It represents an upper limit on spending to acquire new customers.
Software as a Service (“SaaS”) businesses live and die by this metric. Client acquisition costs (“CAC”) take many forms but are traditionally in the form of marketing expenses and attributable salaries for sales staff. For professional services businesses in competitive bid scenarios, discounting is often the common approach to win new work.
So if I want to ‘acquire’ or win a new client, how much should I pay, or in this case, discount?
You need to ask yourself “how much is that client worth to me?” If the client has a high chance of repeat business, the CLV is intrinsically higher. Unless it’s for strategic reasons, the cost of acquisition must be less than this…otherwise you’re just taking on unprofitable clients for ZERO benefit.
The general rule of thumb for SaaS businesses is that the CLV/CAC ratio should be 3x or higher. I haven’t come across any studies on what an appropriate measure is for professional services business, but given that these firms typically transact at an earnings multiple of 3 to 4 times – the ratio isn’t too far off the money.
- Your CLV is directly attributable to your business value
No brainer here. The higher your CLV, the greater your business value. Do you want to maximise the price when you sell your business? Start by maximizing the value of your client base.
How to increase your CLV
- Secure recurring revenue. Think about the ways you can secure revenue into the future and rely less on ‘one off’ transaction work. Examples might be offering retainer based engagements to your A-class clients.
- Your focus should be on growing business by retaining existing customers that bring in real value. It is 5-10 times more costly to get a new customer than to retain an existing one. Studies indicate that increasing customer retention by 50% results in a profit increase of at least 25%.
- Great customer relationships enforce the likelihood of the client using your services in the future. If you develop deep, resounding relationships with your customers, the more likely it is that your customers are going to use you again, which increases their lifetime value to your firm.
- Get a great financial advisor. If your CFO or accountant isn’t having these types of conversations with you, they’re behind the eight ball. Get an advisor that’s ahead of the game.
Now do it
Now go back to your client ledger and work out your CLV. I’ve built a template to make your life easier…if you’d like a copy, flick me an email: Jason@sbo.financial