You will be able to estimate a customer's lifetime value and use it to set the most you can pay to acquire a customer.
Priya runs a maths tuition centre in Singapore for students from P4 up to the PSLE, and she is weighing whether to spend S$150 on ads to win one new student. Her fee is S$300 a month, so S$150 feels like a lot to pay for one student (Priya's figures, and those of the other owner below, are invented examples).
Most small businesses never do this calculation. They spend what feels reasonable and hope it works out. You can replace that feeling with two numbers: what a customer is worth to you over time, and what it costs you to win one. Whether S$150 looks expensive depends on what you compare it against, because next to one month's fee or one term's fee it looks steep, while next to everything a student pays over all the years they stay it can look quite cheap.
Lifetime value is the profit a typical customer brings you over the whole time they buy from you. To get a rough figure, multiply four numbers together: average spend per purchase, purchases per year, years the customer stays, and margin. Margin is the share of each dollar left after the direct costs of serving the customer, which for Priya are the tutor, the materials and her share of rent for that class.
Priya's students pay S$300 a month, 12 times a year. Her records show that students who join in P4 and stay until the PSLE usually stay about 3 years. After direct costs she keeps about 40 cents of every dollar, so her margin is 0.4. The sum is S$300 x 12 x 3 x 0.4 = S$4,320 of profit over the life of one student.
Compare that with a single term. A term is three months of fees, or S$900, and Priya's profit on it is S$360. A student who stays three years is worth twelve times what the first term suggests, so the S$150 she was worried about is a large bite out of S$360 but a small one out of S$4,320.
These figures are estimates, and that is acceptable. Use your own records where you have them, and mark any guess as a guess so you know which figure to check later. What you want from the sum is a rough ceiling on what a customer is worth, so that your spending decisions start from something better than a hunch.
The same formula gives very different answers in different businesses. Mei Ling runs a bakery selling custom cakes. A cake costs about S$80, a typical customer orders twice a year and stays about 3 years, and her margin is about 35 percent. S$80 x 2 x 3 x 0.35 comes to about S$168 of lifetime value, which is much less than Priya's and means Mei Ling can afford to spend far less to win each customer.
Customer acquisition cost is your marketing spend in a period divided by the number of new customers you won in that same period. Count every marketing cost: ads, design, tools, printing, partnership discounts, and the hours you or your staff put in, valued at a fair hourly rate. Add these up for the period, then divide the total by the new customers won in that period.
Last term Priya spent S$1,200 on marketing, plus the equivalent of S$600 in her own time, for a total of S$1,800. She won 15 new students, and S$1,800 divided by 15 gives an acquisition cost of S$120 per student.
Where you can, repeat the sum one channel at a time. An overall average hides the differences between channels, and those differences show you where your next dollar should go. When Priya splits her figures, Google brought in 10 students for S$400 in time and fees, an acquisition cost of S$40 each, while ads brought in 3 students for S$900, or S$300 each. Those two channels cover 13 of her 15 students and S$1,300 of the S$1,800, with the remaining students and spend not assigned to a channel.
A maximum acquisition cost is the most you will spend to win one customer of a given type. Start from lifetime value and set your maximum well below it, for three reasons: your lifetime value is an estimate and may be optimistic, you pay the acquisition cost now while the profit arrives over years, and some customers leave early.
Many owners choose a maximum they could recover fairly quickly. Priya might set hers at S$300 per student, an amount her first-term profit of S$360 roughly covers, so a student who leaves after one term does not lose her money. The size of the cushion is a judgement call that depends on how much cash you have and how confident you are in your lifetime value estimate. Whatever maximum you pick, write down the reason for it so you can check it against your records later.
When it costs more to win a customer than the profit that customer brings, you lose money on every new customer. Say Mei Ling runs ads that bring in customers at S$200 each. Each customer is worth about S$168 in lifetime profit, so she loses S$32 on every new customer the ads bring in. If she doubles her ad budget, she doubles her losses, and her profit stays where it was.
This is the trap of spending more to fix a sales problem, because once each customer loses money, more marketing makes the problem bigger. The fixes that put acquisition cost back below lifetime value are changes to the business itself:
a cheaper channel a higher price a larger order from each customer more repeat orders a better margin
In the activity below you will run the lifetime value sum for one of your own customer types. Use the four figures from your own records, write down which ones are guesses, and set a maximum acquisition cost with a cushion you can explain to a partner or boss.
Pick one type of customer and estimate their lifetime value from your own numbers. Then write down the most you could spend to win one.
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