The calculation for customer lifetime value has three main components:
- The acquisition cost of customer
- The annual profit of customer
- And the lifetime of the customer to the firm
Customer acquisition costs
This is the amount of money it costs, on a per customer basis, to attract a first-time customer. Acquisition costs are calculated by dividing the total promotional spend during a period by the number of new/first-time customers attracted in that same period.
For example, a firm spends $1 million on a TV advertising campaign over the year. Either through market research or their own customer database information, they then work out that business (or brand) has attracted product trials (that is, first-time purchasers) from 10,000 new customers.
Therefore, in this case the acquisition cost on a per customer basis would be the $1 million promotional campaign divided by the 10,000 new customers which equals $100 per customer. (Note: customer lifetime value looks at the profitability and acquisition costs on a per customer basis.)
What types of cost are considered to be acquisition costs?
This is sometimes a debatable area, as a firm or brand will often utilize advertising and other forms of marketing communications to promote to existing customers – either to get them to increase their loyalty or increase the level of purchases. Therefore, it is critical that a firm is able to classify its overall promotional expenditure between campaigns and efforts targeted at new customers and those targeting existing customers.
Typically, to attract first-time customers, the firm would use a mix of advertising, sales promotions (perhaps executed through trade promotions), personal selling, events, and direct marketing. The challenge, as indicated above, for some of these communication tools is that they will have a joint impact on both existing and new customers – such as a sales promotion, where a discount is provided. In this case it is necessary to allocate the promotional expenditure across the existing and new customers.
For example, a discount is provided that is equivalent to a $10,000 investment (as a form of promotion). It is likely that existing customers will be quite responsive to the discount, and some new customers may be attracted and choose to switch away from their existing brand. Either through a review of loyalty data, or a customer database, it should be possible to distinguish between these two types of customers and allocate a proportion of the $10,000 to the overall customer acquisition for the year.