How much is too much to pay for a customer?

Been working with a client recently on the gnarly problems around how much to pay to acquire a customer. Thought it would be useful to share this nifty calculation with represents one way to look at the issue.

Traditionally, companies look at a marketing/sales expenditure to be 15-20% of each revenue dollar. But you may have different models. And, frankly, with almost all the companies I work with, there’s only a very slim marketing budget available. So let’s look at it from the perspective of the lifetime value of a customer:

Lifetime Value equation:

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

– How frequently does your customer buy? (say, 12 times a year with a monthly renewal plan)
– How long does your customer stay with you? (let’s say 1 year for argument’s sake)
– What is your profit? (let’s say $5 a month)

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 traditional rule states 1/3 of the LTV can be spent to acquire a new customer. Using the numbers above, here’s how the equation plays out:

(12 x 1) x ($5) : one third equals $20 to acquire each new customer.

This assumes you have a retention rate within normal ranges—most companies experience 20-25% attrition of customers each year. If it’s more, then there’s a different problem — no brand loyalty.

I’d be curious to know your feedback and experience in similar equation models.