As a business owner, it can be tempting to work with anyone who can fog a mirror. While this may be a necessary tactic in the early stages of your business, it may not be the best long-term strategy for maximum growth and efficiency. Not all clients are created equal and, at some point, you’ll need to key in on the clients that bring the most value for the least amount of effort. In today’s entry, I want to look at 3 ways (metrics) to determine your ideal client and how to use the results to strengthen multiple areas of your business.
Follow Along With The Financially Simple Podcast!
This week on The Financially Simple Podcast:
- (3:14) The Recency, Frequency, Monetary Value Model
- (5:31) Customer Lifetime Value
- (11:26) Customer Acquisition Cost
- (13:11) The CLV Over CAC Metric
- (16:02) How to Use the Results to Grow Your Business
Key Metrics to Determine Your Ideal Client
- How the Recency, Frequency, Monetary Value Model can be used.
- Customer Lifetime Value (CLV).
- Customer Acquisition Cost (CAC).
- Customer Lifetime Value over Customer Acquisition Cost.
Are All Customers Equal? How to Determine Your Ideal Client
Knowing your ideal client can help direct a variety of decisions in your business. It can inform your sales strategy, marketing plans, and even help steer long-term financial decisions. But before you can know who your ideal clients are, you must evaluate them using a few key metrics. Now, we’ll get into those metrics in just a moment. First, we need to look at an old marketing tool to provide us with a starting point.
The Recency, Frequency, Monetary Value Model
Marketing experts have been using this model to identify consumer buying habits within their respective organizations for years. However, the Recency, Frequency, Monetary (RFM) value model can be a useful tool for other areas of your business as well. But what is it?
According to Investopedia, “Recency, frequency, monetary value (RFM) is a model used in marketing analysis that segments a company’s consumer base by their purchasing patterns or habits.” Essentially, this will help you identify the repeatable behaviors of your clients to pinpoint your average client lifecycle. But how does RFM work?
- Recency explains how recently a customer made a purchase.
- Frequency displays how often your client purchases goods or services from you.
- Monetary exhibits the amount of money the client spends on purchases.
Reviewing the RFM for your own client list should provide you with a snapshot of your client’s habits. Look back to the first purchase they made and then their most recent purchase. The time in between should provide you with a general idea of your average customer lifetime. Additionally, RFM will show you how frequently clients are purchasing from you and how much money they’re spending in your business. Each of these numbers is critical in calculating your first metric: Customer Lifetime Value (CLV).
#1 Customer Lifetime Value
Customer Lifetime Value (CLV) represents a customer’s value to a company over a period of time. Understanding the CLV of your clients is important for several reasons which include:
- Providing a powerful base to improve your client retention and experience.
- Helping to create “look alike models” or client personas that mimic your highest value customers.
- Determining which of your revenue offerings produces the greatest return for your investment of time and capital.
While each of these provides a meaningful benefit to your business, none of them is the most valuable aspect of knowing the CLV of your clientele. In my opinion, the most valuable aspect of knowing your CLV is that it allows you to segment your clientele allowing you to invest more in the clients that bring you the highest profit for the least effort. But how do you calculate your Customer Lifetime Value? I’m glad you asked!
Using the RFM model, you should have the average customer lifetime and frequency of purchases. However, you’ll also need to determine your profit per unit/service for each of your revenue offerings. To do this, simply subtract the total cost of the product/service (this includes materials, labor, and overhead) from the total sale price of the product/service. Once you’ve calculated your lifetime, frequency, and profit margin, you’re ready for this simple calculation:
Frequency x Lifetime x Gross Profit (Margin) = Customer Lifetime Value
Let’s put this calculation to work. For the sake of this example, we’ll say the average lifetime of a client is 2 years. During that lifecycle, they purchase your widget 4 times and each unit sold yields a $200 margin. In this scenario, your CLV is $1,600. On the other hand, you’ve got a separate revenue offering that yields just a $100 margin per unit but clients who purchase this offering buy 12 times during their two-year lifecycle. Clients using this offering have a CLV of $2,400.
So, even though the first offering yields a higher margin, clients using the second offering generate a greater Customer Lifetime Value. However, understanding customers’ lifetime value isn’t the only metric used to determine your ideal client.
#2 Customer Acquisition Cost
Another critical metric to determine your ideal client is the Customer Acquisition Cost (CAC). Customer acquisition cost is an approximate calculation of the total cost of acquiring a new customer. These costs include the salaries of your sales and marketing teams, retainers for graphic design and copywriting contractors, and even payment processing fees at your point of sale. But why does CAC matter?
Well, having a CAC that’s disproportionate to your incoming revenues could be disastrous to your company’s long-term health. Put simply, if you spend more to acquire your customers than what they spend in your business, you won’t be able to afford to stay in business. Knowing your Customer Acquisition Cost can empower you to calibrate your investment to attract the highest-value customers and make the right decisions for your growth.
Fortunately, finding your Customer Acquisition Cost is a simple calculation. To find CAC, simply divide the money spent on sales and marketing by the total number of customers you have.
Sales $ + Marketing $ ÷ Total Number of Clients = CAC
Knowing what it costs to acquire your clients has many benefits. However, combining your CAC with your CLV can supercharge your efforts to maximize growth. But how?
#3 The CLV Over CAC Metric
Friends, there is one last metric to consider. The Customer Lifetime Value over Customer Acquisition Cost metric can really provide deeper clarity. But how do you find it? Simply divide your CLV by your CAC.
CLV/CAC = CLV ÷ CAC
But how is this calculation useful? Let’s go back to our previous example. Remember, the clients using offering A had a CLV of $1,600. Those using offering B had a CLV of $2,400. Let’s now assume that offering A has a CAC of $100 and offering B costs $200.
Offering A: $1,600 ÷ $100 = CLV/CAC 16
Offering B: $2,400 ÷ $200 = CLV/CAC 12
In this case, offering A offers a lifetime value of 16 while offering B only offers 12. Therefore, offering A offers the business a greater long-term value. Now that you understand the metrics used to determine ideal clients in your business, how can you use the results?
Applying the Results to Your Business
Without application, all of this is just a neat exercise to see who your highest-value clients are. But we don’t want to waste an opportunity here. There are several ways that you could apply the results of your calculations for the betterment of your business. For example, you could use the results to increase bandwidth and maximize profitability.
You see, sometimes, you have to say, “No’ to good things in order to say, “Yes” to great things. Sometimes, that means saying “No” to certain clients. Using the results of your key metrics, you can segment your current client list into A, B, C, and D clients. Your A clients offer the greatest return on your investment, yielding the highest profitability for the least effort. The B clients also offer a favorable return. However, your C and D clients often require the most work and contribute very little revenue. “Firing” the C and D clients could free up space to take on more of your A and B clients while helping you improve your ROI.
Additionally, you could use the results to fine-tune your sales and marketing. As illustrated in our examples, using the results of these key metrics can help you determine which revenue offerings offer the greatest return. These results can help you identify the common characteristics of your most high-value clients, allowing you to create specific personas to market to.
Similarly, the clarity provided by your findings can be used to shape your sales strategy. As you work through these metrics and further define your ideal customers, you can more directly appeal to their unique needs, creating a greater customer experience and building on your relationship. In turn, this will also enable you to tailor your sales process to them.
Friends, growing a business is tough. It is one of the most challenging things a person could do. Identifying your ideal customers will also reveal those that just don’t really add much value to your business. I realize that you care for all of your clients and it may be very difficult to let some of them go. But sometimes you have to say, “No” to the good things so that you can say, “Yes” to the great things.
I say it all the time. Life is hard but life is good. Friends, determining your highest-value clients to maximize the growth potential of your business can be frustrating but it doesn’t have to be. With these simple metrics and a drive to apply the results, we can make finding the ideal client at least financially simple. Let’s go out and make it a great day!
Do you know which clients are adding the most value to your business? Would you like to learn more ways to improve organizational efficiencies? Reach out to our team. We have trusted advisors all over the country who would love to help you grow your business.