In the early 2000’s Paypal came onto the market trying to build a payment service outside the banking system.
To compete they had to grow fast; really fast.
So they decided to pay people.
New customers got $10 for signing up, and existing ones got $10 for referrals.
Paypal used to literally pay people to become customers and pay people to invite their friends.
These Referrals helped PayPal get 7 to 10% daily growth driving their user base to 100 million customers before they were acquired by ebay.
Paypal could do this because they were hoping that 2 numbers were in their favour – cost of acquisition and customer lifetime value.
What would happen to your growth rate if you could pay people to become customers?
Existing businesses have an advantage over Paypal, who had to bet that paying $20 for a customer would be worth it. Existing businesses can and should work out these numbers right now.
Customer Lifetime Value (CLV) is the single most important metric for understanding your market. Lifetime Value helps you make important decisions across the business about sales, marketing, and operations. For example:
Marketing: How much should I spend to acquire a customer?
Knowing this number enables you to confidently outspend your competition to acquire a customer.
Operations: How much should I spend to service and retain a customer?
Customer service is expensive. Knowing CLV helps you structure this cost base to best serve the most valuable customers and offer service levels that are a competitive advantage.
Sales: What type of customers should we put effort and investment into acquiring?
Most products and services conform to Pareto’s law in some way. Frequently 80% of the revenue is derived from 20% of the customers. Knowing CLV enables you to target more customers who fit into the 20%
Working out CLV is pretty simple.
(Average Value of a Sale) X (Number of Repeat Transactions) X (Average Retention Time for a Typical Customer)
A simple example would be the lifetime value of a software user who spends $50 every month for 3 years. The value of that customer would be:
$50 X 12 months X 3 years = $1800 in total revenue (or $600 per year)
Now you can see even from this hypothetical example why many software providers offer big incentives and long free trial periods to join. If the product operated on a 50% gross margin then they know as long as they spend less than $300 to acquire a new member the customer will prove profitable in within the first year.
Depending the phase and goals of your business you may be able to spend more than the predicted lifetime value of a customer in the hope you can increase the initial value of that customer over their lifetime. We’ve seen many venture backed marketing software companies like Hubspot and Infusionsoft take this approach.
Take the time to do this very simple equation, especially if you’re trying to grow. Knowing your numbers makes your predictions seem right or crazy.
Either way you need to know. Your business depends on it.