Knowing the lifetime customer value (LCV) of a given client is a better indicator of how lucrative your relationship can be than a single project or retainer contract. This is because LCV looks beyond a variable (like number of transactions) to estimate the costs and opportunities for that client in the long-term.
What Is Lifetime Customer Value?
LCV is a prediction of the total revenue a client can bring to your agency for the length of your relationship. Because it's a prediction, LCV is not a measurable statistic. It must be calculated from a model.
Lifetime customer value can be calculated in terms of revenue or net profit. In the example calculations, I will use a revenue-focused model for simplicity. If you have detailed information on per-client, per-project profits, you may wish to analyze LCV based on profitability instead of revenues. Why? Because it's more important to be a profitable agency, rather than a high-revenue agency.
Once you have calculated the LCV of your clients, you can make data-driven choices about how much you are willing to invest to acquire new ones. For instance, if you promote your agency through PPC campaigns, you can set your bids based on your average LCV and your leads' conversion rate.
Also, LCV can determine how much you can afford to offer comps (such as an extra round of revisions) for a given client. Obviously, you can throw in more extras for a client with a higher LCV without breaking the bank in the long term. On the flip side, you can spend more to acquire a client with a higher LCV, knowing the long-term benefits of that relationship will be worth it.
Ultimately, LCV helps you predict your revenue over time, which is essential for running a sustainable agency.
For example, if you set a goal to manage 20 clients on a $5,000 monthly retainer in two years' time, calculating LCV will show you where you are in relation to that goal and which clients can take you there. Your LCV calculations will also be able to tell you if bringing on a new client will pay off once you factor in the resources needed to manage them.
Calculating Lifetime Customer Value for Retainer-Based Clients
Let's use an example of a client who needs SEO and online marketing services. His retainer is around $5,000/month (which is fairly typical). The contract lasts for six months, and the client will continue on a monthly basis.
Calculate a minimum LCV based on the contract.
(monthly amount) X (number of months they use your services) = LCV
You can see that this client will have an LCV of at least $30,000. But his actual LCV will likely be much higher (unless the client has made it clear that he will not need your services after six months or the relationship has already disintegrated beyond repair). The key to figuring out a more accurate LCV for that client is to use your data about past clients to determine how long this client will likely stay with your agency.
Calculate LCV based on past client behavior.
Imagine that this client is a mid-sized company that requires extensive content marketing. Your past experience shows that similar content marketing-focused clients renew their contracts for 2.5 years on average.
(monthly amount) X (average months for similar clients)= LCV
You can use this estimated total to get a LCV of $150,000. To make your LCV calculations even more accurate, your model needs to factor in other variables, such as retention rate and referral rate.
Include retention rate in your LCV calculation.
For instance, how many of those comparable clients left before 2.5 years? Your averages may be skewed thanks to a few outliers. To correct for this, you can find the percentage of clients that left early to calculate a shrinkage factor. Your LCV equation now looks like:
(monthly amount) X (average months X retention rate) = LCV
If your comparable clients have 20% shrinkage, you have a retention rate of 80%. Multiply 0.8 by 30 months to get 24 months of estimated service. Your LCV is now $120,000.
Add potential referral rate to your LCV model.
Another factor in determining the value of a client is the value of their referrals. A client who provides high LCV referrals is more valuable than a client with a higher LCV who does not. You should always track the value of referrals back to the originating client; if you do this, you can build referrals into your LCV model as well.
((monthly amount) X (average months X retention rate)) + (total referral LCV) = LCV
Initially, your LCV for clients will be a rough estimate, and the more clients you work with, the more data you'll have available to increase your accuracy. However, even an estimate can be extremely helpful for an agency. It allows you to start to make strategic decisions about which clients to take on based on the value a client will offer your agency instead of anecdotal data. For example, if you find that content marketing clients stay for 2.5 years with 80% retention, and PPC clients stay for 12 months with 60% retention, it's clear whom you should focus on acquiring.
Calculating LCV for Project-Based Clients
The same principles apply for project-based clients, and the basic equation for LCV looks similar:
(project amount) X (average repeat projects for similar customers) = LCV
If a client pays for a $30,000 web development project, and similar clients contract for two projects, that client is worth $60,000. But another factor essential for determining project-based LCV is upselling. How much could you potentially upsell given the type of client and his budget? If past experience shows that comparable clients have paid for $5,000 worth of upsells on average for each project, that should be factored into your numbers.
(project amount + Total dollar value of average upsells) X (average repeat projects for similar customers) = LCV
The LCV is now $70,000, assuming you don't also persuade them to sign an ongoing retainer.
How to Improve Lifetime Customer Value
Retaining clients is the single biggest factor you can change to improve your agency's average LCV.
If you work mostly with project-based clients, upsells are the only way a client will spend more on an initial project. If you turn him into a repeat client, it will multiply his LCV with each new project. You can also accomplish this by getting selling him on a retainer.
Keep project-based clients returning.
Start by taking good care of them. When clients like working with you and they keep getting results, they're more likely to return. Beyond that, though, it's up to you to manage the upsell process. Want to make upsells easier? Track an internal list of client requests and opportunities on a per-client basis. This gives you a list of things for your account managers to pitch later.
Keep retainer-based clients renewing.
Client retention is just as important for retainer-based clients. They always have a chance to do repeat business beyond the terms in their contract. If you can keep a two-year client with your agency for a third year, you just boosted his LCV by 50%.
Want to sell retainer clients a larger retainer? Keep track of all the "wouldn't it be cool if..." requests they have. The more they want things outside their current retainer, the stronger the potential to sell them a larger retainer.
To further explore lifetime customer value, check out this infographic on calculating LCV. It adds the profit side of calculating LCV, explaining how to calculate advanced variables such as average gross margin per customer lifespan.
What will you change at your agency, now that you can calculate LCV? Share your comment below!
Originally published Mar 12, 2015 7:00:00 AM, updated July 28 2017