Marketing Math II
Customer Lifetime Value and Implications
Deepak Sirdeshmukh, North Carolina State University, 2010
CUSTOMER EQUITY (Customer Lifetime Value) Customer acquisition, development and retention efforts should focus on building a base of customers of high value – or high equity. These are part of the firm’s assets. Customer equity is “a combination of a firm’s current customer assets and the value of the firm’s potential customer assets” (Hogan et al. 2002). Formally, customer equity can be calculated by estimating each customer’s value to the firm (customer lifetime value) and summing up the lifetime values of all the customers. Customer equity depends on The intrinsic value of the consumer The company’s access and fit with the segment Competitive profile of the segment and competitive intensity
DECONSTRUCTING CUSTOMER EQUITY Volume/Range of purchases per period (Q) CUSTOMER REVENUES
Margin per Unit of purchase after tax (Π) Duration of purchase stream (t = 1…n)
CUSTOMER EQUITY
Influence potential (Weighted) (I)
Acquisition (A)
MARKETING COSTS
Development (D)
Retention (R)
Price/ Commission
Cost of goods sold/service
THREE MAJOR OPTIONS FOR ENHANCING CUSTOMER EQUITY (OF A LINE OF BUSINESS)
Growth in LOB Value
Acquisition of valuable new customer relationships
Development of existing customer relationships
Retention of valuable customer relationships
We will look at several quantitative examples in Marketing Math II
Estimating CLV of a Segment (From Wayland and Cole, 1997) Segment Equity (SE) = Equity of each customer X Number of customers in segment n Segment Equity (SE) = N
∑ (Q
t
t=0 Where,
n π t) d t – N
∑ (A
t
+ Dt + Rt).dt
t =0
N = number of customers in the segment t = time periods across which to integrate CLV n = number of periods in customer lifetime for specific product or service Q = quantity of purchase π = margin of each purchase A = Acquisition costs D = Development costs R = Retention costs d = discount rate based on cost of capital
Estimating CLV of a Segment (From Gupta and Lehmann, 2007; Gupta, 2009) T
CLV =
∑
N*
where,
(Mt rt)
(1+ i)t t=0
- AC
Mt =margin or cash received by the firm from consumer purchases at time t, i = discount rate or cost of capital for the firm, rt =probability of customer repeat buying or being “alive” t AC= acquisition cost T = time horizon for estimating CLV N = Number of customers in segment
at time
Estimating CLV of a Segment (From Gupta and Lehmann, 2007; Gupta, 2009) Gupta and Lehmann demonstrate that assuming constant retention rates and margins and an infinite time horizon (where lifetime is driven by retention rates), the CLV computation simplifies to:
N*m
r (1+ i- r)
- AC
Essentially, the computation simplifies to applying a “multiplier” to unit margin and deducting the acquisition cost, then multiplying by the number of customers. For a simple example, such as the one from the text, we can use this equation or compute using Excel.
Example, simulating an example using data from the exhibit in Kotler and Keller (originally from Lehman & Gupta) Step: Calculating Acquisition Costs * This first step demonstrates how the acquisition cost of $40 may be determined. Calculating Acquisition Costs
Say using an existing list of customers
Acquisition costs can either be directly measured or allocated. Say cost of a direct mailing campaign per prospect (catalogs, letters, other collateral)
$1.00
Number of prospects targeted
4000
Response rate (inquiries generated)
5%
Number of inquiries
200
Conversion rate Number of acquired customers Acquisition cost of acquired customers
50% 100 Total campaign cost/number of acquired customers $40.00
What are the factors driving response rate and coversion numbers?
Improving Acquisition Efficiency * This first step demonstrates how the acquisition cost of $40 may be determined. Calculating Acquisition Costs
Say using a pre-qualified list of customers from a broker Each name costs $ .5, but promises a doubling of response rates.
Acquisition costs can either be directly measured or allocated. Say cost of a direct mailing campaign per prospect (catalogs, letters, other collateral)
$1.50 ( add .5 cost of each name)
Number of prospects targeted
4000
Response rate (inquiries generated)
10%
Number of inquiries
400
Conversion rate
60% (say conversion rates go up by 20% from baseline)
Number of acquired customers Acquisition cost of acquired customers
240 Total campaign cost/number of acquired customers $25.00
So, while the initial cost may go up, the total acquisition cost goes down. What are the factors driving response rate and coversion numbers?
Baseline Case CURRENT PERIOD 0 Number of customers 100 Implied retention rate % Revenue per customer 0.00 Variable cost per customer 0.00 *Marketing costs per customer Acquistion 40.00 Development Retention TOTAL 40.00 Contribution (margin) per customer -40.00 Total contribution or loss -4,000.00 **Present Value -4,000.00 Cumulative NPV $9,286.51 Average value of 100 customers acquired $92.87
Years 1
2
3
4
5
6
7
8
9
10
90 90.00 100.00 70.00
80 88.89 110.00 72.00
72 90.00 120.00 75.00
60 83.33 125.00 76.00
48 80.00 130.00 78.00
34 70.83 135.00 79.00
23 67.65 140.00 80.00
12 52.17 142.00 81.00
6 50.00 143.00 82.00
2 33.33 145.00 83.00
30.00 2,700.00 2,454.55
38.00 3,040.00 2,512.40
45.00 3,240.00 2,434.26
49.00 2,940.00 2,008.06
52.00 2,496.00 1,549.82
56.00 1,904.00 1,074.76
60.00 1,380.00 708.16
61.00 732.00 341.48
61.00 366.00 155.22
62.00 124.00 47.81
I am using the table from the text (Kotler&Keller, page 66) and making various modifications. The example assesses lifetime value of a cohort of 100 customers acquired in year 0. Note, the example does no include fixed costs.
* Note, if we were not able to measure these costs as variable, we would allocate them from fixed costs. ** I used the implied discount rate of 10%, so there is some variance from the table in your text.
Baseline Case
Baseline Case with Lower Acquisition Costs CURRENT PERIOD
Number of customers Implied retention rate % Revenue per customer Variable cost per customer *Marketing costs per customer Acquistion Development Retention TOTAL Contribution (margin) per customer Total contribution or loss **Present Value Cumulative NPV Average value of 100 customers acquired
Years 0
1
2
3
4
5
6
7
8
9
10
100
90 90.00 100.00 70.00
80 88.89 110.00 72.00
72 90.00 120.00 75.00
60 83.33 125.00 76.00
48 80.00 130.00 78.00
34 70.83 135.00 79.00
23 67.65 140.00 80.00
12 52.17 142.00 81.00
6 50.00 143.00 82.00
2 33.33 145.00 83.00
30.00 2,700.00 2,454.55
38.00 3,040.00 2,512.40
45.00 3,240.00 2,434.26
49.00 2,940.00 2,008.06
52.00 2,496.00 1,549.82
56.00 1,904.00 1,074.76
60.00 1,380.00 708.16
61.00 732.00 341.48
61.00 366.00 155.22
62.00 124.00 47.81
0.00 0.00 25.00
25.00 -25.00 -2,500.00 -2,500.00 $10,786.51 $107.87
I am using the table from the text (Kotler&Keller, page 66) and making various modifications. The example assesses lifetime value of a cohort of 100 customers acquired in year 0. Note, the example does no include fixed costs.
* Note, if we were not able to measure these costs as variable, we would allocate them from fixed costs. ** I used the implied discount rate of 10%, so there is some variance from the table in your text.
Baseline Case (With lower acquisition rates) (With lower acquisition rates)
Estimating Impact of Customer Development Strategy (Say Cross-Selling another line of products) CURRENT PERIOD
Number of customers Implied retention rate % Revenue per customer Variable cost per customer *Marketing costs per customer Acquistion Development Retention TOTAL Contribution (margin) per customer Total contribution or loss **Present Value Cumulative NPV Average value of 100 customers acquired
Years 0
1
2
3
4
5
6
7
8
9
10
100
90 90.00 100.00 70.00
80 88.89 110.00 72.00
72 90.00 120.00 75.00
60 83.33 125.00 76.00
48 80.00 130.00 78.00
34 70.83 135.00 79.00
23 67.65 140.00 80.00
12 52.17 142.00 81.00
6 50.00 143.00 82.00
2 33.33 145.00 83.00
10.80
11.25
11.40
10.80 27.20 2,726.00 2,252.89 -$609.38
11.25 33.75 2,970.00 2,231.40
11.40 37.60 2,724.75 1,861.04
52.00 2,496.00 1,549.82
56.00 1,904.00 1,074.76
60.00 1,380.00 708.16
61.00 732.00 341.48
61.00 366.00 155.22
62.00 124.00 47.81
0.00 0.00 40.00
40.00 -40.00 30.00 -4,000.00 2,700.00 -4,000.00 2,454.55 $8,677.13 Change $86.77 Change
-$6.09
I am using the table from the text (Kotler&Keller, page 66) and making various modifications. The example assesses lifetime value of a cohort of 100 customers acquired in year 0. Note, the example does no include fixed costs.
* Note, if we were not able to measure these costs as variable, we would allocate them from fixed costs. ** I used the implied discount rate of 10%, so there is some variance from the table in your text.
Projected Intervention Invest in customer development in years 2,3,4 - to cross-sell
15% of annual variable costs
Project 25% of customers are converted
25% increase in revenues per converted customer
Estimating impact of customer retention investments Years
CURRENT PERIOD
Number of customers Implied retention rate Revenue per customer Variable cost per customer *Marketing costs per customer Acquistion Development Retention TOTAL Contribution (margin) per customer Total contribution or loss **Present Value Cumulative NPV Average value of 100 customers acquired
0
1
2
3
4
5
6
7
8
9
10
100
95 95.00 100 73.5
89 93.89 110 75.6
85 95.00 120 78.75
75 88.33 125 79.8
64 85.00 130 81.9
48 75.83 135 82.95
35 72.65 140 84
20 57.17 142 85.05
11 55.00 143 86.1
4 38.33 145 87.15
0 0
40 0 0 0 0 0 40 0 -40 26.5 -4000 2517.5 -4000 $2,288.64 $10,978.71 Change $109.79 Change
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 34.4 41.25 45.2 48.1 52.05 56 56.95 56.9 57.85 3068.288889 3495.307 3383.175 3060.202 2511.226 1962.778 1141.234 627.1277 244.4127 $2,535.78 2626.076 2310.754 1900.144 1417.522 1007.215 532.3942 265.9634 94.23166 $1,692.20 All numbers in $ $16.92
I am using the table from the text (Kotler&Keller, page 66) and making various modifications. The example assesses lifetime value of a cohort of 100 customers acquired in year 0. Note, the example does no include fixed costs.
* Note, if we were not able to measure these costs as variable, we would allocate them from fixed costs. ** I used the implied discount rate of 10%, so there is some variance from the table in your text.
Projected Intervention 5% (from baseline) increase in variable costs 5% increase in retention rate
Constant margin and retention rate examples CURRENT PERIOD 0 Number of customers Implied retention rate % Revenue per customer Variable cost per customer *Marketing costs per customer Acquistion Development Retention TOTAL Contribution (margin) per customer Total contribution or loss **Present Value Cumulative NPV Average value of 100 customers acquired
100 0.00 0.00
Years 1
2
3
4
5
6
7
8
9
10
70 70.00 100.00 70.00
49 70.00 100.00 70.00
34 70.00 100.00 70.00
24 70.00 100.00 70.00
17 70.00 100.00 70.00
12 70.00 100.00 70.00
8 70.00 100.00 70.00
6 70.00 100.00 70.00
4 70.00 100.00 70.00
3 70.00 100.00 70.00
30.00 2,100.00 1,909.09
30.00 1,470.00 1,214.88
30.00 1,029.00 773.10
30.00 720.30 491.97
30.00 504.21 313.07
30.00 352.95 199.23
30.00 247.06 126.78
30.00 172.94 80.68
30.00 121.06 51.34
30.00 84.74 32.67
40.00
40.00 -40.00 -4,000.00 -4,000.00 1,192.82 11.93
I am using the table from the text (Kotler&Keller, page 66) and making various modifications.
All numbers in $ Interest rate
1.1 0.909091
The example assesses lifetime value of a cohort of 100 customers acquired in year 0. Note, the example does no include fixed costs.
* Note, if we were not able to measure these costs as variable, we would allocate them from fixed costs. ** I used the implied discount rate of 10%, so there is some variance from the table in your text.
Constant margin and retention rates Note results using the formula from Gupta and Lehman are very similar.
Using the simplified formula from Lehman 0.7 1.75 1+ .10-.75 0.4
52.5
12.5
N*m
r (1+ i- r)
- AC
Placing the Value of CLV calculations in Context Break-Even Analysis: We have examined break-even calculations for a new product launch (Marketing Math 1, Mountain Man). Using CLV, we can examine the cost of breaking even on a customer acquisition, development, or retention strategy. That is, we can slice the quantitative analysis using a different tool .
Marketing mix changes: We have discussed how to go about selecting alternate marketing mix elements (product, brand, etc) based on sound judgments. Using CLV, we can supplement these judgments with real or projected profitability of alternate marketing mix elements or interventions.
Target Market Selection: We have discussed using market analysis (3Cs) to judge and select target customers. Using CLV, we can supplement these judgments with real or projected profitability of alternate segments.
Essentially, sound quantitative insights should supplement rather than replace market insights.
