Every day, marketing and sales professionals in thousands of B2B companies make significant investments to acquire and develop sales leads. The ultimate objective is to grow revenues and profits by winning new customers. Unfortunately, these investment decisions are often made without a clear and accurate understanding of how valuable leads actually are. When marketing and sales leaders don't know the true value of their sales leads, they can invest too little and miss out on profitable new revenues, or they can invest too much and acquire customers that are unprofitable.
Knowing the true value of sales leads is particularly important for B2B companies with long and complex demand generation cycles. In these situations, the purchase decision is the end result of a buying process that contains multiple steps and often extends over a period of several months. Demand generation investments must be made to acquire new leads, and additional investments are required to move those leads through the revenue pipeline. To manage demand generation spending effectively, you need to know the value of leads at various stages of the process.
Determining the value of sales leads is a four-step process. In this post, I'll discuss the first two steps, and I'll cover the last two steps in my next post.
Estimate Customer Lifetime Value
The first step in determining the value of sales leads is to estimate the value of a new customer for your business. Customer value establishes the ceiling for how much you should invest to acquire a new customer because new customers will contribute to profitable growth only if the value they create exceeds the costs you incur to acquire them. For this purpose, value means customer lifetime value, which can be defined as the present value of the total profits that a company expects to earn from a customer over the full duration of the customer relationship.
There are several methods for calculating customer lifetime value. One of the more simple formulas is:
CLV = m(r/(1+i-r))
where CLV = customer lifetime value
m = annual gross profit
r = customer retention rate
i = discount rate
We can use a simple example to illustrate how the formula works. Suppose that your comany sells marketing asset management (MAM) solutions to corporate customers. The average new MAM customer produces annual gross revenues of $100,000 and an annual gross profit of $30,000. Your customer retention rate for new MAM customers is 90%, and your discount rate is 10%. If we insert these values into the formula, the calculation would be:
CLV = $30,000(.9/(1+.1-.9))
CLV = $30,000(.9/.2)
CLV = $30,000(4.5)
CLV = $135,000
On these facts, therefore, each new MAM customer that you acquire is worth $135,000 to your company.
Calculate the Maximum Allowable Investment
As I noted earlier, the value of a new customer sets the ceiling for how much you can spend to acquire that customer without diluting company profits. However, when customer acquisition costs are equal to customer lifetime value, your company will not earn a return on your acquisition investment. Therefore, it's important to determine how much you can spend to acquire a new customer and earn an acceptable return on your acquisition investment. I call this the maximum allowable investment.
The formula for calculating the maximum allowable investment is:
Maximum allowable investment = CLV/(1+ROI Threshhold)
In this formula, CLV is the customer lifetime value, and ROI Threshhold is your minimum acceptable ROI on demand generation investments. If we assume that your ROI Threshhold is 15%, the maximum allowable investment would be calculated as follows:
Maximum allowable investment = $135,000/(1+.15)
Maximum allowable investment = $135,000/1.15
Maximum allowable investment = $117,391.30
So, in this example, the most you should spend to acquire a new MAM customer is approximately $117,000.
In my next post, I'll discuss the final two steps in the process for calculating lead value. I've recently published a white paper that explains this process in greater detail. If you'd like a copy of this white paper, send an e-mail to ddodd(at)pointbalance(dot)com.