One of the goals of our Small Business series here at Uprise RI is to introduce helpful ‘big business’ concepts to small business owners. Big businesses bring in hefty profits because they understand the fundamentals of acquiring and keeping customers. After this brief overview, you will too!

So what are these numbers that every small business owner should know and measure?

Customer Lifetime Value (LTV):
Imagine you own a cozy coffee shop in Providence. LTV is the total amount of money a single customer will spend at your coffee shop over the entire time they remain a customer. So, if a regular customer visits your shop for 5 years and spends $5 every week, their LTV would be $5 x 52 weeks x 5 years = $1,300. This means, over 5 years, you can expect that one loyal customer to bring in $1,300.

Why it’s important: Knowing the LTV helps you understand how much you can spend in acquiring a new customer and still make a profit. The higher your LTV, the more you can afford to spend to gain new customers.

Customer Acquisition Cost (CAC):
Now, let’s say you decide to run a local ad campaign to attract more customers to your coffee shop. The CAC is the cost of that campaign divided by the number of new customers it brings in. If you spend $500 on the campaign and gain 50 new customers, your CAC is $500 ÷ 50 = $10. This means you spent $10 to get each new customer through the door.

Why it’s important: If your CAC is higher than the profit you make from a new customer over a reasonable period of time, you’re losing money. Ideally, you want the CAC to be lower than the LTV, ensuring you’re making more from a customer than you spent to acquire them.

Contribution Margin LTV (CMLTV):
This is the most important metric and measures your LTV after subtracting all the variable costs associated with serving that customer. Let’s go back to your coffee shop. If a customer’s lifetime value (LTV) is $1,300 over 5 years, but during that time, you spent $300 on coffee beans, milk, and other costs to serve them, then the Contribution Margin LTV is $1,300 – $300 = $1,000. This is the actual profit you make from that customer over their lifetime, after accounting for costs.

Why it’s important: This gives you a clearer picture of your true profits from each customer. It helps in pricing decisions, cost-cutting measures, and understanding the overall health of your business.

How to Utilize These Concepts:

1. Prioritize Customer Retention: If you know a customer’s LTV is high, it makes sense to invest in keeping them happy and loyal. Maybe introduce a loyalty program or special offers for regulars.
2. Optimize Marketing Spend: If your CAC is too high, consider more cost-effective marketing strategies or refine your current ones to get better results.
3. Manage Costs: Knowing the Contribution Margin LTV can help you identify areas where you can reduce costs and increase your profit margins.

Understanding LTV, CAC, and CMLTV can provide valuable insights into how to grow and sustain your small business. By focusing on these metrics, you can make informed decisions that lead to increased profitability.