Transcript Using Lifetime Value to Determine Your Marketing Strategy Direct Marketing Association Tues. Oct 19 2004, 2:15 – 3:15 Morial Convention Center New Orleans, LA Arthur Middleton.

Using Lifetime Value to Determine
Your Marketing Strategy
Direct Marketing Association
Tues. Oct 19 2004, 2:15 – 3:15
Morial Convention Center
New Orleans, LA
Arthur Middleton Hughes
VP / Solutions Architect
What KnowledgeBase Marketing
Does
How a modern database
system works
Customer
Transactions
Marketing
Database
Inputs from Retail,
Phone, Web
Data Access
And Analysis
Software
Marketing
Staff
Appended
Data
Two Kinds of Database People
Constructors
People who build databases
Merge/Purge, Hardware, Software
Creators
People who understand strategy
Build loyalty and repeat sales
You need both kinds!
What proves that
relationship building
works?
• Manufacturer of indoor lighting products
• Catalog sent to 45,000 contractors
• Previous policy: wait for the orders
• Test: pick 1,200 customers, split into test of
600 and control of 600
• Two person pilot program build relationship
with test customers to see the results
Change in the number of orders
112%
120%
82%
100%
Change in
number of
orders
80%
60%
40%
20%
0%
1
2
Control vs Test Groups
Change in the Average Order
Size
114%
120%
86%
100%
80%
Change in
average 60%
order size
40%
20%
0%
1
2
Control vs Test Group
Total revenue gain: $2.6 million
dollars
127%
140%
120%
100%
Change in
total
revenue
70%
80%
60%
40%
20%
0%
1
2
Control vs Test Group
This stuff works!
Building a relationship with
customers can be highly
profitable
Using a database to recreate the
old family grocer is a winning
strategy
Relationship marketing is the
way to go
Why long term loyal customers
are important. They:
• Buy more per year
• Buy higher priced options
• Buy more often
• Are less price sensitive
• Are less costly to serve
• Are more loyal
• Have a higher lifetime value
Retention is the way to measure
loyalty
90%
80%
70%
Percentage
Retained
from
Previous
Year
60%
50%
40%
30%
20%
10%
0%
1
2
3
4
Years as a customer
5
Retention pays better than
acquisition
Annual Profit
$48
$60
$40
$20
$0
($20)
($40)
($60)
($80)
($62)
New Customer
3rd Year
Customer
Lifetime
Value
Why we need 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
Lifetime Value Analysis
Goal: Determine...
• 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 lifetime value?
• Net present value of the profit to be
realized on the average new customer
during a given number of years.
• To compute it, you must be able to
track customers from year to year.
• Main use: To evaluate strategy.
Examples of Profitable Strategies
User Groups
Newsletters
Surveys and Responses
Loyalty Programs
Customer and Technical Services
Membership cards and status levels
Event Driven Communications
Event driven communication:
Dear Mr. Hughes:
Ridgeway Fashions
Leesburg, VA 22069
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 wrap the suit at no extra charge and
deliver it to you next week, so that you will have it in plenty of
time for her birthday. Or, I can put it aside so you can come in to
pick it up. Please call me at (703) 754-4470 to let me know which
you’d prefer.
Sincerely yours,
Robin Baumgartner
Robin Baumgartner, Store Manager
Lets look at a retail operation
• Before and after a loyalty program
LTV Before New Strategies
Year 1
40%
200,000
1.4
$50
$14,000,000
Year 2
45%
80,000
1.6
$60
$7,680,000
Year 3
50%
36,000
1.8
$70
$4,536,000
50%
Cost Percentage
$7,000,000
Costs
$6,400,000
Acquisition Cost $32
$13,400,000
Total Costs
49%
$3,763,200
48%
$2,177,280
$3,763,200
$2,177,280
$600,000
1
$600,000
$600,000
$3.00
$3,916,800
1.12
$3,497,143
$4,097,143
$20.49
$2,358,720
1.32
$1,786,909
$5,884,052
$29.42
Retention Rate
Customers
Visits Per Year
Spending Per Visit
Revenue
Profit
Discount Rate
NPV Profit
Cum NPV Profie
Lifetime Value
Discount Rate Basic Formula
Market Rate of Interest...5%
Assume Risk (Double rate)...10%
Years = n Interest = i
Formula: D = (1 + i)n
Calculation of rate after 2 years:
 D = (1 + .10)2 = (1.10)2 = 1.21
New Retention Strategies
Provide all customers with a
card or register their credit
cards
Birthday Club
Communicate with them
Give them premiums if they
shop a lot
Lets see what could happen
With New Strategies
Retention Rate
Customers
Visits Per Year
Spending Per Visit
Revenue
Year 1
50%
200,000
1.6
$55
$17,600,000
Year 2
60%
100,000
2
$70
$14,000,000
Year 3
65%
60,000
2.4
$80
$11,520,000
Cost Percentage
Costs
Acquisition Cost $32
Database Costs
Loyalty Program
Loyalty Costs
Total Costs
50%
$8,800,000
$6,400,000
$500,000
$5.00
$1,600,000
$17,300,000
49%
$6,860,000
48%
$5,529,600
$250,000
$8.00
$1,600,000
$8,710,000
$150,000
$10.00
$1,440,000
$7,119,600
$300,000
1
$300,000
$300,000
$1.50
$5,290,000
1.12
$4,723,214
$5,023,214
$25.12
$4,400,400
1.32
$3,333,636
$8,356,851
$41.78
Profit
Discount Rate
NPV Profit
Cum NPV Profie
Lifetime Value
Effect of adoption of new
strategies
Old LTV
New LTV
Change
With 200,000 members
Year 1
$3.00
$1.50
-$1.50
-$300,000
Year 2
$20.49
$25.12
$4.63
$926,071
Year 3
$29.42
$41.78
$12.36
$2,472,799
What is the proper computation
period?
• Which is the correct lifetime value? 1, 2, 3, 4, 5 or
more years?
• They are all correct. Which you use depends on
your product or service.
• Long lifetimes: banks, insurance, utilities.
• Short lifetimes: discount houses, package goods,
catalogers.
Five Ways to Boost LTV with
Database Strategies
• Increase the retention rate
• Increase the referral rate
• Increase the spending rate
• Decrease the direct costs
• Decrease the marketing costs
How to use lifetime value
• Compute a base lifetime value
• Dream up a new strategy. Estimate the benefits
and costs
• Determine whether your new lifetime value goes
up or goes down
• Don’t undertake any new strategy until you can
prove it will be successful
Customer Segmentation
Segments are essential for
marketing
• Many customers are quite different in their purchase
patterns
• Create actionable segments and determine the value of
each
• Use the results to focus your retention programs and
acquisition programs on the most profitable segments
What doesn’t work:
Treating all customers alike
79.67%
This 28% lost 22% of the
bank’s profits!
80.00%
60.00%
24.82%
40.00%
15.83%
1.52%
20.00%
0.00%
-20.00%
Bank Customers by Profitability
-21.83%
-40.00%
5%
11%
28%
28%
28%
Marketing to Customer
Segments
Your Best Customers 80% of Revenue
Your Best Hope for New
Gold Customers
1% of Total
Revenue
GOLD
Move Up
These may be losers
Spend Service
Dollars Here
Spend Marketing
Dollars Here
Reactivate or
Archive
Using lifetime value to get
budget approval
• Database marketing budgets are usually
carved from somewhere else
• You have to prove that you will make better
use of the funds than the others
• Lifetime value can supply testable numbers
that CFO’s can understand
• Base your budget on solid numbers backed up
by valid tests
What your new budget will buy
Old LTV
New LTV
Change
With 200,000 members
Year 1
$3.00
$1.50
-$1.50
-$300,000
Year 2
$20.49
$25.12
$4.63
$926,071
Year 3
$29.42
$41.78
$12.36
$2,472,799
How you got there
Retention Rate
Customers
Visits Per Year
Spending Per Visit
Revenue
Year 1
50%
200,000
1.6
$55
$17,600,000
Year 2
60%
100,000
2
$70
$14,000,000
Year 3
65%
60,000
2.4
$80
$11,520,000
Cost Percentage
Costs
Acquisition Cost $32
Database Costs
Loyalty Program
Loyalty Costs
Total Costs
50%
$8,800,000
$6,400,000
$500,000
$5.00
$1,600,000
$17,300,000
49%
$6,860,000
48%
$5,529,600
$250,000
$8.00
$1,600,000
$8,710,000
$150,000
$10.00
$1,440,000
$7,119,600
$300,000
1
$300,000
$300,000
$1.50
$5,290,000
1.12
$4,723,214
$5,023,214
$25.12
$4,400,400
1.32
$3,333,636
$8,356,851
$41.78
Profit
Discount Rate
NPV Profit
Cum NPV Profie
Lifetime Value
Using lifetime value to get
budget approval
• Database marketing budgets are usually
carved from somewhere else
• You have to prove that you will make better
use of the funds than the others
• Lifetime value can supply testable numbers
that CFO’s can understand
• Base your budget on solid numbers backed
up by valid tests
Who is going to defect?
• Besides LTV, you can develop a model
that predicts which customers are most
likely to leave.
• Putting that model with LTV you can
refocus your entire retention strategy
• You create a Risk Revenue Matrix
Focus on A and B: 44% of your
customers.
LTV
High
Medium
Low
Probability of Leaving Soon
High
Medium Low
Priority A Priority B Priority C
Priority B Priority B Priority C
Priority C Priority C Priority C
Conclusion: you can do this
• Create a lifetime value table for your
customers.
• Put LTV into each customer record
• Use LTV to determine your marketing
strategy
• Use it to improve retention, cross sales,
and profits
Books by Arthur Hughes
From McGraw Hill. Order at
www.dbmarketing.com
Contact Arthur: [email protected]