Starbucks estimates that the average lifetime value of their customer is $14,099. – Kissmetrics
You probably already know this, but it’s worth a refresher: arguably the two most important numbers in any business are the customer acquisition cost (CAC) and the customer lifetime value (CLV). Focus on improving just these two metrics, and you’re light years ahead of most of your competitors.
- Why are these numbers so important?
- And how can doing something as seemingly minor as tweaking your customer contracts have a dramatic positive effect on your CLV (and thus the health of your entire business?)
To the first point… this blog post from ForEntrepreneurs.com does a nice job of framing the importance of CAC and CLV:“Business model viability, in the majority of startups, will come down to balancing [these] two variables… To compute the cost to acquire a customer, CAC, you would take your entire cost of sales and marketing over a given period, including salaries and other headcount related expenses, and divide it by the number of customers that you acquired in that period. (In pure web businesses where the headcount doesn’t need to grow as customer acquisition scales, it is also very useful to look customer acquisition costs without the headcount costs.)
To compute the Lifetime Value of a Customer, CLV, you would look at the Gross Margin that you would expect to make from that customer over the lifetime of your relationship. Gross Margin should take into consideration any support, installation, and servicing costs. It doesn’t take a genius to understand that business model failure comes when CAC (the cost to acquire customers) exceeds CLV (the ability to monetize those customers. A well balanced business model requires that CAC is significantly less than CLV.”
Makes sense, right?
Well, if that’s all correct, then it is vitally important to come up with creative, robust ways to improve CLV. Common strategies include:
- Increase your average transaction amount. Let’s say you run a restaurant where the average customer spends $35 per meal, including tax and tip. By toying with the menu—adding a prix fixe weekend brunch, perhaps—you bring the average customer spend to $45.
- Expand retention programs. Maybe you run a web design business based on a subscription model. Your customers pay you $500/month on average. If you increase the length the average client stays with you by just two months, you’ve increased your CLV by $1,000!
- Increase the number of transactions per customer. Perhaps you run a copywriting business that sells white paper writing services for $1,500 each, and the average client buys 4 white papers. By increasing that number to 6 (probably not impossible), your CLV climbs by an impressive $3,000.
The Vastly Underappreciated Influence of Your Contracts on CLVEach of your customers is worth MORE than you think. – Spencer Smith
Business contracts are like airbags in a car or guardrails on a freeway. Most of the time, they just abide in the background. But when something goes wrong, they better work! The consequences of failure can be catastrophic—and possibly even fatal to the business.
A contract dispute with a vendor that lands in litigation, for instance, not only likely means the end of a once-fruitful partnership, but it also creates cascading indirect costs:
- The vendor shares her bad experience with other vendors, making it harder for you to attract great talent;
- The legal drama saps morale, making it harder for you to recruit/keep an awesome team;
- The attention deficit created in your company causes you to miss out on profitable opportunities;
- And so on.
The National Center for State Courts (NCSC) went to great lengths to quantify the costs of contract disputes using something called the Civil Litigation Cost Model (CLCM) to estimate “the time expended by attorneys to resolve a “typical” automobile tort, premises liability, professional malpractice, breach of contract, employment dispute, and real property dispute.” Now mind you, the CLCM model only looked at attorney fees—not the other consequences we just discussed. Still, it found that, regardless of the nature of the conflict, the average contract dispute costs ~$91,000.Understand the implications here for your CLV! Nearly $100,000 customer value can be quickly reduced to $0 or, worse, negative $100,000. Every non-payment or loss because of a customer dispute decreases the average lifetime value of your customers.
Now you get the scope of the issue. So what to do about it?
How to Increase CLV with Customer Contracts Tailored to Your Needs
Six best practices:
- Include provisions to prevent future liability because of a customer dispute;
- Develop creative contract terms to improve payment;
- Grab a copy of our Customer Contract Checklist;
- Review our “Value of a Lead” Spreadsheet;
- Watch our video below about what needs to be included in your customer contracts;
- Schedule a call with us today to discuss how to improve your customer contracts!