Customer Acquisition and Spending

I found a great article from Go-To-Market-Strategies. It is vital that a company knows how much they can spend in acquiring new clients. See below:

How Much Can You Afford To Spend On Customer Acquisition?

As sales and marketing teams develop and implement marketing budgets, they rely on many metrics to guide them. What was spent last year? What does the industry typically spend as a percentage of revenue? How much is needed to implement the planned activities? And so on.

What is often not asked is perhaps the most critical metric of all. How much can you afford to spend to acquire a new customer? The path to answering this question boils down to knowing your Lifetime Customer Value. The Lifetime Value (LTV) of a Customer is built from the following equation:

LTV = (Frequency of Purchase) X (Duration of Loyalty) X (Gross Profit)

How frequently does your customer buy?

How long does your customer stay with you?

What is your profit? (average order size minus average order cost of goods, fulfillment,
and service)

Take the average for each of these three questions and plug that into the LTV equation, and you have your Lifetime Gross Profit contribution of a customer. From there you can answer the question “How much can you afford to acquire a new customer?”

A good rule of thumb to follow when answering this question is 1/3 of the LTV can be spent to acquire a new customer. This assumes you have a retention rate within normal ranges—most companies experience 20-25% attrition each year. If your customer attrition rate is much higher than 25%, you may have a brand loyalty problem that should be addressed immediately. Remember, it costs 5x more to acquire a new customer than it does to retain an existing one. Also, if 1/3 your LTV is less than 10% as a percentage of sales, you may have an overhead expense problem that needs to be addressed.

Calculating your Lifetime Value of a Customer will not only help you determine what you can afford to spend on sales and marketing, but it also will help you identify other issues you may need to address outside of the budgeting process (e.g. attrition and overly burdensome overhead costs).

http://www.gtms-inc.com/tip_customerlifetimevalue.htm