You will be able to estimate customer lifetime value and use it to set a maximum cost to acquire a customer.
Priya is deciding whether to spend S$150 on ads to win one new student for her maths tuition centre. Measured against one month's fee, it feels like too much. Measured against what that student brings in over the years they stay, it might be cheap. Which comparison is right decides whether she should spend at all, and how hard she can push.
Most small businesses never do this sum. They spend what feels reasonable and hope it works out. This lesson gives you two numbers that replace the feeling: what a customer is worth over time, and what you are paying to win one.
Lifetime value is the profit a typical customer brings you over the whole time they buy from you. A rough version needs four figures, multiplied together:
the average amount they spend each time they buy how many times they buy in a year how many years they stay a customer your margin, the share of each dollar left after the direct costs of serving them
Take Priya's centre, with example figures. A student pays S$300 a month, and pays twelve times a year. Looking back at her records, students who join in P4 usually stay until the PSLE, so about three years. After paying the tutor, materials and her share of rent for that class, about 40 cents of every dollar is left. That gives S$300 x 12 x 3 x 0.4, which comes to S$4,320 of profit over the life of one student.
Compare that with one term. Three months of fees is S$900, and the profit on it is S$360. A student who stays three years is worth twelve times as much as the first term suggests. That changes the question about the S$150 ad spend. Against S$360 it is a large bite. Against S$4,320 it is small.
The figures are estimates, and that's fine. Use your own records where you have them and mark guesses as guesses. The point of the sum is to put a rough ceiling on what a customer is worth, so your spending decisions start from something better than a hunch.
Lifetime value varies a lot between businesses. Mei Ling's bakery, with example figures, sells a custom cake for about S$80. A typical customer orders twice a year for family birthdays and keeps ordering for about three years, with a margin of about 35 percent. That is S$80 x 2 x 3 x 0.35, or about S$168. Same formula, very different answer, and a very different amount she can afford to spend winning each customer.
Customer acquisition cost is what you spent on marketing in a period, divided by the number of new customers you won in that period. Count all of it: ads, design, tools, printing, partnership discounts, and the hours you or your staff spent, valued at a fair hourly rate.
Say Priya spent S$1,200 on marketing last term and the equivalent of S$600 in her own time, and won 15 new students. Her acquisition cost is S$1,800 divided by 15, which is S$120 per student. These are example figures again.
Look at one channel at a time where you can. If Google brought in 10 of those students and cost S$400 in time and fees, its acquisition cost is S$40. If the ads brought in 3 and cost S$900, they cost S$300 each. The average hides that difference, and the difference is what tells you where the next dollar should go.
Once you know both numbers, you can set a maximum acquisition cost: the most you will spend to win one customer of this type. It has to sit well below lifetime value, for three reasons. Your lifetime value is an estimate and may be optimistic. You pay the acquisition cost now, while the profit trickles in over years. And some customers leave early.
So many owners choose a maximum they could recover fairly quickly. Priya might decide she will pay up to S$300 to win a student, which the first term's profit roughly covers, even though the full lifetime value is much higher. If a student leaves after one term, she hasn't lost money on them. The exact cushion is a judgement call that depends on your cash and your confidence in the estimate. Write down the reason for the number you pick.
Now the uncomfortable case. Suppose Mei Ling runs ads that bring in customers at S$200 each, but each customer is only worth about S$168 in profit over their lifetime. Every new customer loses her S$32. If she doubles the ad budget, she doesn't double her profit. She doubles her losses.
This is the trap of spending more to fix a sales problem. When acquisition cost is higher than the profit a customer brings, extra marketing makes the problem bigger. The fix lies elsewhere: a cheaper channel, a higher price, a larger order per customer, more repeat orders, or a better margin. Any of those moves the two numbers back into the right order.
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.
Estimate the lifetime value of one customer type using your own numbers and write the most you could spend to win one.
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