Transcript Lifetime Value Calculation

Why Start with a Customer
For a company to be successful, it must :
• Understand the customer
– All customers are not alike!
• Identify their preferences
– Customers have different needs!
• Deliver value
- Today,s customer is in the driver’s seat !
If you don’t know where you are
going you probably aren't going to get there
The fundamental principle of Marketing is:
To target a specific niche market as
your point of attack and focus all your
resources on achieving the dominant
leadership position in that segment
High risk low data decision
The market we will enter will not
have experienced our type of
product before.
 We are in high risk low data state.
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Lack of Data
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The only proper response to this situation
is to acknowledge the lack of data as a
condition of the process.
To be sure, you can fight back against
this ignorance by gathering highly
focused data yourself.
You can not expect to transform a low
data situation to high data situation
quickly.
Memorable Images
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Only work with memorable images.
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Please note that we are not focusing
on target market characterization.
But target customer.
Let Them Guide Us
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Markets are impersonal abstract things
like the PC market
Neither the names nor the descriptions of
markets evoke any memorable images.
We need something that feels a lot more
like real people.
We are just going to have to make them
up.
We can let them guide us to developing a
truly responsive approach to their needs.
Target Customer
Characterization
A formal process for making up
these images, getting them out of
individual heads and in front of a
marketing decision making group.
Target Customer
Characterization
Create as many characterizations as
possible
 Built a basic library of possible
target customer profiles
 Apply techniques to reduce these
data into a prioritized list of
desirable target market segment
opportunities.
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Sample Scenario for a Pen
based Laptop Customer
Personal profile and job description
 Technical resources (environment)
 A day in life (before)
 The problem your product solves
 A day in life (after)
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We are still operating in a low data
situation
 We just have a better set of material
to work with.
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Value Triad
Customer
Value
Proposition
Product
Application
Market
Assumption: People will respond better to promotions,products tailored
to their needs
Segmented Market
Objective: Find homogenous groups of people
-so each group can be sent a different promotion
-tailored to its needs.
Segmentation Techniques
Behavioral
Enterprise
Value
Lifecycle
Other
Other
Segmentation Segmentation Segmentation Segmentation Segmentations
Segmentations
RFM
Geographic
Demographic
Psychographics
(AOI)
Customers
How valuable
expectations and
the customers
Are and can be to the needs change
over the course
Company LTV
Of the Lifecycle
Segmentation
Key principles of
segmentation
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Once a customer has purchased a product or service he or
she is likely to purchase again from the same source.
Assuming the customer had a good experience
 Segment customers from non customers
• Than focus resources on repeat sales to the same
customers.
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By learning more about the best customers marketer can
maximize profits.
All customers do not purchase the same product for the
same reason.
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Seniors and kids purchase aspirin for different reasons
Lifetime Value
The Criterion of Strategy
The Loyalty Effect
Accountants have developed
sophisticated techniques for
appraising capital assets and their
depreciation;
 They have learned how to monitor
the constantly changing value of
work-in-progress; but they have not
yet devised a way to track the value
of a company's customer inventory.
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Accountants
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They make no distinction between the
sales revenue from brand new customers
and sales revenue from long term, loyal
customers, because they don’t know or
care it costs much more to serve new
customers than an old one.
Worse accountant treat investment in
customer acquisition as one more current
expense instead of assigning it to specific
customer accounts and amortizing it over
the life of the customer relationship.
Why Lifetime Value
Analysis?
• We need to know the value of our customers, so as to
properly target our sales and retention efforts.
• We need to discriminate among our customers to acquire
and retain the best.
The Importance of Measurements
• Measures determine vision and strategy deciding what to
measure and how to link measures to incentives are
the most important DBM decisions.
• NPV of customer base should be at the top of the
measurement hierarchy.
LTV Analysis Goal:
Determine…
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Where to put your retention dollars
The value of each retention strategy
Where to put your acquisition dollars
How much to spend on acquisition
What is Life Time Value
• NPV of the profit to be realized on the average new
customer during a given number of years.
• Life time value is goodwill
• To compute it you must be able to track customers from
year to year
• Main use: To evaluate strategy
Birthday Club Strategy
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We will examine Ridgeway Fashions
before and after it adopted the new
strategy of writing letters to husbands
before their wives birthdays.
While this is a retail example the
principles apply to any kind of industry.
Financial,Telecommunications, B2B
Variable Costs
Include any variable cost.
 Do not include fix costs rent long
term debt overhead. These costs do
not vary with number of customers.
 The costs of servicing a customer
tend to decrease with the number of
years that the customer has been
buying from you.
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Acquisition Cost
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Marketing + Sales
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Money you spend during the year.
Than
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Marketing+Sales/the number
of new customers who actually
make purchases from you each
year.
The Discount Rate
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The profits you receive from your
customers come in over several years.
Money received in future years is not
worth as much as money received today.
We must discount it by a certain
percentage so we can equate it to the
present money.
Use the market rate of interest to
discount the future revenue
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And include the risk factor
How to figure the Discount
Rate
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Market Rate of Interest...8%
Assume Risk (Double rate)...16%
Years = n Interest = i
Formula: D = (1 + i)n
Calculation of rate after 2 years:
D = (1 + .16)2 = (1.16)2 = 1.35
Profits
 NPV
Profits : Gross Profits /
Discount rate
 Cumulative NPV profits
NPV year 1 + NPV year 2 + NPV
year 3
LTV
 LTV
:
Cumulative NPV profits in each year /
original group of customers
Calculating LTV
In other words, lifetime value is
the value of a newly acquired
customer.
The LTV of the average new customer
for Ridgeway in the 3rd year is 60.05
1,201,057 / 20,000 = $60.05
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LTV Table’s Significance
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Typically, the lifetime value numbers in
and of themselves have no particular
significance.
What makes them important is when they
are used in comparison with other
numbers to evaluate the effect of
proposed strategies.
What Life Time Value table shows is that
if the new strategies were to be
adopted…..
Ridgeway Fashions
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Assumption: The birthday club will
be successful and there will be a 5
% referral rate.
Assumptions
5 percent of her customers will
recommend Ridgeway to their
friends or relatives.
 As a result we will have 5 percent
more customers in year 2 than we
otherwise would have had.
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Assumptions
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Spending rate, Loyal customers will buy more than new customers.
 As customers drop out, those who are left are the more loyal
customers.
To set the club up in the 1st year will cost $15 per customer.
 This includes training of the clerks to ask people to join the club and
giving the clerks a commission of $5/customer sign up in addition:
• Getting the survey data
• Entering the data,
• Putting it into the database
• Creating the birthday club software
• Writing one letter to each members husband at birthday time.
 In years 2 and 3 the costs are set at $3 per year.
You will note that she is sending out birthday letters to all club members,
even though many have already stopped buying in the store.
Gains from Birthday Club
Year 1
Year 2
Year 3
Old LTV
$20.00
$47.59
$60.05
New LTV
$17.00
$58.94
$86.00
Change
($3.00)
$11.35
$25.95
With 200,000 Customers
($600,000) $2,270,690 $5,189,801
Event driven
communication:
Ridgeway Fashions
Leesburg, VA 22069
Dear Mr. Hughes:
I would like to remind you that your wife Helena’s birthday is coming
up in two weeks on November 5th. We have the perfect gift for her in
stock.
As you know, she loves Liz Claiborne clothing. We have an absolutely
beautiful new suit in blue, her favorite color, in a fourteen, her
size, priced at $232.00.
If you like, I can gift
it to you next week, so
her birthday. Or, I can
Please call me at (703)
wrap the suit at no extra charge and deliver
that you will have it in plenty of time for
put it aside so you can come in to pick it up.
754-4470 to let me know which you’d prefer.
Sincerely yours,
Robin Baumgartner
Robin Baumgartner, Store Manager
Recency, Frequency, Monetary
Analysis
RFM
Direct Marketers have been using
RFM Analysis to predict customer
behavior for more than 50 years.
 It is the basis for any model of
customer behavior
 You only need your Customer
database with purchase history. You
don’t need to hire a statistician.
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RFM
The predictor of future behavior is
past behavior
 RFM is pure behavior, it only works
with customer files
 It requires knowledge of the
customer purchase history.
 It works with any industry.
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How to code your
customers by Recency
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03/20/2001
You need the most
recent purchase date.
Divide the database
into 5 exactly equal
parts.
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Number 5 ( the most
recent )
Down to 1 ( the most
ancient )
5
4
3
2
1
11/20/1998
Response by Recency Quintile
The customers were offered a video package that cost them about $100
including S&H charges.The graph represents the responses to a test
mailing to 30 000 of 2.1 million names.
How to code your
customers by Frequency
You need
the total
number of
times that
the customer
has made a
purchase
from you.
3.254
5
4
Average
products
purchased
per month
1
3
2
1
Frequency
Average number of telephone calls
made per month
 Total number of checks and deposits
made during a month
 This is a measure of how important
is doing business with you is in the
minds of your customers.
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Response by Frequency Quintile
Lowest quintile contains
an abnormal number of
recent buyers. Joined
yesterday.This customer
did not have the chance
to become a frequent
buyer yet
Frequency is also a good predictor of behavior but much less so than
Recency.
How to code your
customers by Monetary
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We need the
total amount
spent on our
products or
services,per
month,per year
or in some
other way.
$12,456
Average
amount
purchased
per month
$10
5
4
3
2
1
Response by Monetary Quintile
Monetary response to $100
product
1.61%
Monetary response to $5000
product
Monetary coding is far less predictive of behavior than either
recency or frequency.
Putting It All Together
RFM Code Construction
R
5
F
35
4
34
3
33
2
32
31
1
Database
One Sort
Five
Sorts
M
335
334
333
332
331
Twentyfive sorts
Creating an Nth
300 000 Records
Results of test mailing $100 offer
to 30 000 customers
34 of 125 cells better than
breakeven
RFM Cell
X axis represents the RFM cell codes and Y axis represents
The breakeven index of each cell. Cost per price / net profit from a single sale
Profit=$40 each successful sale
Cost= $0.55 The rate needed for each RFM cell was %1.35
Profit from Test Mailing
For a net cost of $420 the company learned how 30,000 customer,
an Nth of it s 2.1 million customer database would respond to this offer.
Test Full File & RFM Selects Compared
Test v.s. Response Rates