SME: Calculating Customer Cost & Value

The recent 2016 SME Development Survey conducted by DP Information Group reveals that on top of the usual 3 cost challenges – manpower, materials, and rents, an additional one has surfaced. The cost of financing has challenged SMEs; 46% naming higher bank interest rates, 34% said suppliers were tightening credit assess, and 19% said more collateral are required to maintain their loans. These operational costs erodes the SMEs of their profit, and certainly needs to be address.

Despite the urgency to lower them, another critical cost that should not be neglected is the cost of acquiring a customer.  How much does your customer cost?

Customer Acquisition Cost (CAC)

CAC is the price you have to pay to convince a potential customer to buy a product or service. This is calculated by:

This metric is crucial, especially to early stages of an enterprise because you need customers to survive and grow thereafter. However, it costs money to acquire customers. The question is, what is the cost of acquiring one, and how does that affects profitability?

Lifetime Value (LTV)

This brings us to another metric, the Lifetime Value (LTV). LTV is the ability to monetize the customers, and is computed by:

A business model therefore can be successful only if LTV is significantly higher than CAC. As a general guideline:

• LTV > CAC. (It appears that LTV should be about 3 × CAC for a viable recurring revenue model.)
• Aim to recover CAC in < 12 months, otherwise your business will require too much capital to grow.

Suggestions to increase profitability

Ultimately, an enterprise has to generate profits by decreasing cost and increasing revenues. Some methods of reducing customer cost/CAC includes:

• Inbound marketing: Using marketing to bring potential customers to you, instead of having marketing efforts fight for their attention
• Strategic partnerships: partnership with various companies to bring in a steady supply of customers
• Viral marketing: using existing social network/technology to spread viral messages that appeal to individuals with high social networking potential

Some methods to increase LTV includes:

• Enhancing user value: ability to generate something pleasing to users such as improving qualities/features that consumers expressed interest in
• Implementing Customer Relationship Management (CRM): examples such as cloud-based sales tracking system, blogs, techniques to capture customer loyalty
• Customer satisfaction boost: increasing customer satisfaction by identifying gaps in products and services.

Conclusion

CAC and LTV are important metrics that determine the profitability of an enterprise. A computation of these metrics whenever the data is available helps the enterprise to identify the viability of the business model. Subsequently, business plans may be adjusted and new features/services can be implemented to decrease CAC and LTV.

References

Hubspot. (n.d.). Inbound-marketing, 23 December 2016, link

Hughes, C. (n.d.). Customer Acquisition Cost: The One Metric That Can Determine Your Company’s Fate,  23 December 2016, link

SHIAO, V. (2016, Nov 3). Financing emerges as new cost challenge for SMEs: survey, BusinessTimes,  23 December 2016, link 

Skok, D. (n.d.). Startup Killer: the Cost of Customer Acquisition. ENTREPRENEURS, 23 December 2016, link