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Lifetime Value of Customers

While we are discussing economic concepts, let's also discuss the important concept of "lifetime value of customers".  People are the most important asset of any company, whether they be the employees, the customers, the reliable suppliers, or the steady-as-she-goes long-term investors.  Unfortunately, these "soft" assets don't even get reflected in the balance sheets of the company.

Customers can have enormous value to the company, especially if they are loyal customers who will be making additional purchases in the future.  Because of that, companies are willing to spend sometimes enormous amounts to get a new customer, even to lose money on the first sale.  

Is that nuts?  Not at all, if there are "backend" products to make second sales, or if the customer will make repeat purchases as book buyers do at Amazon.com.  

Let's demonstrate with a hypothetical example:

Let's say the the first sale to a customer brings in $100 in revenues, but it costs $125 to get that first sale, counting all costs.  Not so good so far.  But if that customer will continue to purchase items which allows the company to make $25 profit per year from then on, it may not be so bad.  

Applying the capitalization concepts, with a market interest rate of perhaps 10%, that would equate to a capitalized value of $250, not bad considering it cost the company a net $25 to acquire that customer. Well with any company, there will be a drop out rate of customers, so we can't use the multiplier of 10, but maybe 5, but even $125 is not bad. 

The multiplier will be different for each company depending upon the loyalty and degree of repeat business achieved by the company.  The more loyal the customer base, the higher the multiple.  For more on this, read "The Loyalty Effect" by by Frederick F. Reichheld (available from Amazon.com)  

No wonder investors like Amazon.com despite Amazon.com currently losing money.  They are accumulating an enormous asset in lifetime customer values - if they can retain the customers.