The Lifetime Value of a Client
Every practice wants to build a loyal client base. One of the most satisfying aspects of working in the veterinary industry is to watch pets grow from puppies and kittens into healthy adult dogs and cats. Serving the health needs of pets throughout their lifetime involves adopting a relational orientation to drive the practice's revenue and profit. Lifetime value provides a quantitative measure of how successful the practice is in nurturing client loyalty.
What Is Lifetime Value?
When a practice embraces a relational orientation, it stops thinking of individual client visits or purchases, and thinks in terms of client relationships. The practice manager's goal shifts from maximizing the revenue or profit from each transaction to maximizing the profit earned over the entire client relationship. Lifetime value is defined as the present value of all future profits earned from the client over the course of their relationship with the practice.
How to Calculate LTV
To calculate the client's lifetime value (LTV) to the practice, the manager needs to know four pieces of information: the margin earned from the client, the practice's retention rate, the interest rate, and the average customer acquisition cost. All variables (except the acquisition cost) are calculated on an annual basis to produce the client's LTV. Let's consider each variable in more detail:
- Margin. Margin is the gross profit earned by the practice from the sales of its products and services to the client over the course of the year. For each product or service, the margin is calculated as price minus variable costs. Thus, if a client purchases a service priced at $150 and costs the practice $60 in variable costs to offer, the margin will be $90.
- Retention Rate. The retention rate reflects the loyalty of the practice's clients. Every year, some clients may leave the practice never to return, either because they go to a competitor or their pet passes away. Retention rate is defined as the percentage of existing clients that remain with the practice at the end of the year. For example, if a practice has 200 clients and 20 clients leave the practice during the year, its retention rate will be 90% (200 minus 20, divided by 200).
- Interest Rate. The interest rate allows the practice manager to discount future profits from the client to the present value. The manager can use the current interest rate they would pay to borrow money from a financial institution, or they can use the value they typically use for discounted cash flow analysis.
- Customer Acquisition Cost (CAC). Customer acquisition cost is the amount spent by the practice on marketing and sales activities to acquire each new client. To calculate this value, the manager adds up all their acquisition marketing expenses over the year, and then divides this amount by the number of new customers acquired by the practice. The CAC is a measure of how effective and efficient the practice's marketing is. Managing CAC carefully will allow the practice to enjoy a higher lifetime value.
Using Lifetime Value
Let's consider an example showing how to apply the lifetime value equation to a practice's economics. Assume that a practice spends an average of $250 to acquire a new client and has an interest rate of 5%. Further, assume that it earns a margin of $15 per month from the client (or $180 each year) and its retention rate is 88% (it loses 1% of its clients each month). Applying the equation, the client's lifetime value for this practice will be $808.82.
As the example illustrates, services for which clients pay every month, such as a preventive care plan, contribute positively to the lifetime value. It also shows just how important customer loyalty is from an economic standpoint, and how losing one customer can lead to a lifetime value loss of hundreds of dollars.