Not all customers are the same. Some customers spend more than others. There are some are quick to pay invoices and others are slow and need reminders. While others are needy, disrespectful, impossible to please, or abusive of guarantees and return policies.
In an article titled, “When Should You Fire Customers?” MIT Sloan suggests the bulk of profit comes from the top 20 percent of customers, the middle 70 percent are break even, and the bottom 10 percent loses businesses money. But when you have a lot of customers and little time, how do you figure out the characteristics of each? The answer is simple – with metrics!
Just as you use numbers to help better understand your company, you can also measure the performance of customers and how they affect your business. Here are seven metrics to help support better customer relationship strategies and decisions.
1. Customer acquisition cost
The cost of how you originally obtain a customer through promotional campaigns and sales efforts is usually a company-wide metric that measures marketing efficiency. You divide total marketing and sales costs by the total number of customers. The more it costs to attract a customer, the more profit they must generate in order for you to make a profit.
However, you can’t blindly apply averages to individuals. The more accurately you track acquisition costs for individual customers, the better you can see how much profit you will need to make. It can also help identify the expense it might be worth to retain someone to get them past the initial acquisition expense.
2. Customer lifetime value
Customer lifetime value (CLV) is the total amount customers spend with a company over time. It should be the gross margin — sales minus cost of goods and direct transaction expenses — that results from revenue. For example, a customer who spends more and receives a higher discount may not provide as much gross margin as one who pays higher prices on a lower volume. The average CLV gives you an idea of how high average acquisition costs can run.
Like acquisition cost, you can’t apply an average CLV to all customers. You don’t even know what a given customer’s lifetime is until they no longer do business with you. Instead, keep a running tally of revenue and margin. Pair that with a specific acquisition cost and you can see how specific customers move toward overall profitability.
Also, realize that customers may bring value in other ways. They might test products, provide introductions to new customers, promote the company on social media, or give reliable and useful feedback. Don’t make the mistake of looking only at money spent. Think about the additional benefits as financial contributions to your business.
3. Customer profitability
You’ll want to know how profitable your customers are to your business. While this may seem similar to CLV, it’s a bit different. CLV measures gross margin. Look beyond the sales margins toward the costs of service: A customer who increases your cost to serve them lowers your profits more than customers who need less attention.
Calculating the expense of such support can be detailed, but it’s worth the effort. The more precise you can be, the more easily you see if a customer who seems big in terms of raw sales is really as valuable as other customers. Vlasic Pickles, for example, had a high-volume customer who reduced their profit margins enough that the company ultimately had to file for bankruptcy.
4. Return rate
Returns mean loss of sales revenue, increased handling costs, and possibly the loss of the cost of the product. Some amount of overall returns is inevitable. Depending on the industry and sales mechanism, it can run as high as 50 percent. (And you thought youwere having a bad day.)
Return rates will vary by customer. If you don’t track returns per customer, you can lose track of net revenue and the resulting margin. You also miss a chance to spot problems that could be corrected. A customer with an unusually high rate might benefit from a different sales method, education, or consulting, improving the purchase experience and your net results.
5. Average order size
You have two customers who order the same amount of goods over a year, but one does half the number of orders, each at twice the size of the second customer. That means less operational cost and, potentially, more profit. You might even be able to provide a higher discount level and still do better, taking both margin and reduced operational expenses into account.
6. Days sales outstanding
Days sales outstanding, or DSO, measures the average number of days it takes to collect on a sale. DSO lets you know how quickly you’re bringing in cash, which is vital to your business.
Do the same thing for individual customers, by examining their payment histories, continually updated. Not only can you see if you’re providing what becomes a free line of credit, but an individual DSO that increases over time can also be an early warning of growing risk.
7. Customer satisfaction
Typically done with surveys, a customer satisfaction score can provide multiple benefits. You can see growing disappointment that requires an intervention and is perhaps an indication of something wrong in how your organization operates. High satisfaction can help identify prospects for increased business and referrals.