This is the second in a series of articles exploring business metrics and their usefulness in the engineering software space. In the last post, we covered using overall market data to measure success. This post discusses the cost of acquiring and keeping customers. It’s not an easy metric to capture, but In too many cases, it turns out that the cost for a specific customer is higher than expected and may even exceed the revenue actually obtained from the customer, effectively removing any profit from the equation. Tied to this is the concept of “customer lifetime value”; we’ll explore how this ties into acquisition cost and the need to establish a plan for each account.

Let’s start with a story. Many years ago I worked at Computervision (CV), a CAD pioneer that collapsed due to poor decision-making and leveraged buyout fever but that spawned countless great software entrepreneurs, companies and products. During one phase of its long demise, I ran CV’s Integration group for the CADDS product line. Our team was trying to build and test software on far too many UNIX platforms, one at the specific demand of a single client. I have no idea what it cost to acquire that customer, but I know that it likely cost us more in machines and personnel to maintain that platform than the revenue from the release would bring in. CV desperately needed the cash the customer provided, so we soldiered on. It taught me several important lessons: (1) be very, very careful with cash and (2) think rationally about why you support the customers you support — and how.

Awareness+Brochure+Rep = Sale
Most companies take a simple approach to calculating customer acquisition cost. A trade show, for example, has costs for the booth space, staff, sales collateral, and giveaways. Add those up, divide by the number of leads, and we get to cost per lead. If some of those leads turn into sales, add in any additional expenses to close the sale and we arrive at the cost to acquire those particular customers. Include a bit more to cover activities to build awareness, something for the web presence, and we get to an approximate cost to acquire a new customer. The result is an inexact figure, at best, since

• sales of engineering software often have a long awareness-building phase that may no be accurately represented in a “given period” that it typically an accounting year;
• sales of certain types of tools are driven by “what I learned in school”, so factoring the educational discounts would be appropriate; and
• business consolidation often results in unit sales that are not selected by the actual user, skewing the results.

Even with these flaws, so long as an organization applies its own system with consistency, a dollar total for customer acquisition cost should be readily achievable and can be monitored over time. If it’s going up, why? What has changed? Is print advertising no longer working? Flying prospects to meetings getting too expensive? If down, what new channels are working? Can this be expanded upon?

How much is this customer costing us?
But the point of the exercise is not to only determine if account attraction is succeeding; it is to see whether the accounts are being leveraged to their fullest. A business school metric that more and more companies are looking at is “Customer Lifetime Value” or the dollar value of the customer relationship over its anticipated lifetime. To take a grossly simplified example:

year 0: account cost $50 to acquire, netted revenue of $200 at a gross margin of 80%. Profit = $110
year 1: revenue of $50, cost to service account of $30. Profit = $20
year 2: same. Profit = $20
year 3: same. Profit = $20
year 4: uh oh. Customer wants higher level of service at same cost. Profit = $0

And so on. The lifetime value of this account is the net present value of the projected future cash flows. SInce $1 today is guaranteed to be both realized and worth $1, it’s a 100% certainty. $1 in 4 years may not materialize because the customer disappears and inflation may make it worth less than $1.

For the sake of simplicity, assume no inflation and a perfect world so that $1 in 4 years is as likely to appear and is worth as much as $1 today. This account then has a lifetime value of $170.

The point is not to bog down in math but to highlight several things:

1. Accounts should be viewed as profit-generators over a number of years, not just marquee names or revenue line items for one year.
2. Given enough history with similar accounts, it should be possible to plan for the eventual dip in revenue or profit from an account. The account manager should have a plan in place to revitalize the account when profit starts to dip below the cost to acquire a new account.
3. If accounts typically agitate for discounts starting in year 4, why? What can be done to prevent this? Is it a product, services or sales problem?

In my CV example, above, the customer was generating revenue, but at what I believe was probably an operating loss. The account was generating desperately needed cash, however, and had strategic value to a struggling company. How many unprofitable customers are you holding on to because of loyalty or for their strategic importance or for some other, qualitative, reason? It may be a perfectly valid reason, and the end-decision may be to keep the account under its present terms, but looking at customer lifetime value will provide data to help in that determination.

On the flip side: are you spending as much as you could be on customer acquisition? Customer lifetime value can also be seen as the upper limit to what you might be willing to pay to acquire a customer relationship — or to keep it and avoid losing the account to a competitor.

Next week: now that you’ve won (or kept) a profitable customer, are you maximizing the revenue from the account?

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