The Value of Customers
Marketing Analysis: Our Roadmap
Overview: Customer Value Management (CVM)
Quantifying
Value
Services
Identifying &
Developing
Good Customers
Brand Value
Customer
Dynamics &
Loyalty
Value Pricing
Executing
CVM
Channel Value
Marketing Analysis: Our Roadmap
Overview: Customer Value Management (CVM)
Quantifying
Value
Calculating Acquisition Cost
Lifetime Value of Customer
Which Value to Use?
Marketing Analysis: Our Roadmap
Overview: Customer Value Management (CVM)
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Quantifying
Value
Calculating Acquisition Cost
Customer Acquisition and Retention: The Gamble Analogy
1) A spend of $A per prospect will convert them to customers with
some probability (a) < 1.
2) $A, and therefore a will be different for different methods of
prospecting
a1
ail
M
ect
r
i
D
A1
A2
Ph
on
eS
ale
Acquire
1-a1 Not Acquire
a2
Acquire
1-a2 Not Acquire
Customer Acquisition - Retention
Approach to calculating A / R cost:
For A: Estimate total prospecting cost
For R: Estimate total retention payout (e.g. by
discounts, other incentives)
Estimate total number of new customers or
customers who stay
Divide to get the A or R cost per final customer
Example of Acquisition Cost Calculations
Prospect = A possible customer, anyone who is contacted by
marketing
Customer = An entity that you actually do business with
Example: A service provider acquires customers through
2 methods:
a) Direct mail (5000 mails sent out at $6 each)
b) Direct phone calls (10000 calls made at $10 each)
Suppose:
a) 5% of direct mail prospects become customers
b) 15% of called prospects become customers
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Example of Acquisition Costs
Calculations*
Citibank NA (Singapore) acquires credit card customers through
4 types of solicitation methods:
a) Direct mail
b) Take-one
c) Direct sales (10 calls / day)
d) Bind-ins
Qualification: 2/3 of respondents to direct mail or direct sales qualify
1/3 of respondents to take-one or bind-in qualify
Conversion: 80% of qualified applicants became card customers
*Source: Citibank: Launching the Credit Card in Asia Pacific, HBS Case, 1997, V. Kasturi Rangan
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Basic Cost Data
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Analysis of Acquisition Cost
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Why is the Calculation of Acquisition
Cost Useful?
1) Strategy Decisions: If Acquisition Cost >
Retention Cost, focus more on penetration and
retention strategies
2) Choosing or Prioritizing between various
mechanisms of acquisition or retention: Choose
the one with the lowest cost
3) Calculation of marketing contribution in a
marketing P/L sheet.
4) Customer Value assessments
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Caveats
Independence between methods of
prospecting
Level of analysis changes
Prospecting methods could result in
customers of different value
The relevant metric to use could be
V: If customers have already been acquired
V-A: Prior to acquisition
A: If V is not expected to be different
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Marketing Analysis: Our Roadmap
Overview: Customer Value Management (CVM)
Quantifying
Value
Calculating Acquisition Cost
Lifetime Value of Customer
V = t (Rt - Ct) / (1+ i)t
Net Value = V - A
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Lifetime Value of a Customer
How much is a customer worth to you over the lifetime of
your relationship (in dollar terms)?
Consider product category - Shampoo
Suppose a customer uses two bottles each year, contribution
from each is $25
Over the lifetime, the value will be
V = 50 / (1+i) + 50 / (1+i)2 + .. <- This is a perpetuity
V = 50 (1/i) = 50 (1/0.12) = $416.67
If acquisition cost > V, then it is not worth acquiring the customer as
they will not be worth that much.
This analysis lets you make decisions about how much to
spend on acquisition!
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A simple LTV problem
+100
+100
+100
+100
+100
Customer life = 5 years
Annual contribution = $100
Interest rate = 10%
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Question 1:
What happens if the life increases from 5 years to 7 years?
Extending the life of the customer is worth $107.76
(40% increase in life causes 28% increase in LTV
Leverage = 28/40 = 0.70)
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Question 2:
What happens if the annual profit increases from $100 to $120?
Improving annual profits is worth $75.83
(20% increase in annual profit causes about 20% increase in LTV
Leverage = 20 / 20 = 1)
Worksheet: LTV and Leverage Change
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Lifetime Value of Customers
Case 1: Calyx and Corolla
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Value of Customers
1000 Prospects
1.5% Returns from Prospecting
5% Return from Customers
12 catalogs (solicitations) per year
Catlog Production and Shipping Cost: 32 cents / catlog
Catlog Mailing List Cost: 8 cents / catlog
Average contribution per order = $22
Initial prospecting: 1000 x 40 cents = $400
Number of customers = 1.5% of 1000 = 15
Initial contribution from them = $22 x 15 = $330
These 15 customers get 12 catalogs per year, so annual cost = 15 x 12 x 32 cents =
$57.6
Average orders per year = Number of catalogs x 5% = 15 x 12 x 5% = 9
So annual contribution from orders = 9 x $22 = $198
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Initially
Investment
Initial Prospecting
Annual Catalog to Customers
Cash Contribution from Orders
Initial Response
Annual Response from Cust
Free Cash Flow
Years 1-5
Year 6
($57.60)
$198
($400)
$330
($70)
$140.40
Assuming an interest rate of 10%, the value of the customer net of marketing costs is:
V = -70 + 140.4 / 1.1 + 140.4 / 1.1 2 + .. + 140.4 / 1.1 5
V = $460.71 per 1000 prospects (at 10%)
V = $348.69 per 1000 prospects (at 20%)
Hence, the profit potential is pretty high
Note that without the LTV calculations (future benefits), the catalog would
have been deemed to be unprofitable
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Lifetime Value of Customers
Case 2: Brita Water Filter
The product: A water filter jug (purchased
once), filters have to be replaced on an
ongoing basis
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Lifetime Value of a Customer with a Pitcher at Home
Assumptions: 50% of advertising induces pitcher buying and filter buying each
Advertising has effects in the current period alone
Contribution
from pitcher
Contribution from filter sales
Marketing expenses for filter sales
Marketing cost
for pitcher
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Lifetime Value of a Customer with a Pitcher at Home
Assumptions: 50% of advertising induces pitcher buying and filter buying each
Advertising has effects in the current period alone
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Sensitivity Analysis Offers Strategic Options
Scenario 1: All held constant, suppose filter purchase doubles
LTV changes from $12.23 to $22.98 (Leverage = 0.88)
Brita could spend upto $10 per customer to double their filter consumption.
Tactics: Automatic replenishment, home delivery, health benefit, reminders
Scenario 2: Instead of 5 years, pitcher life is 10 years
LTV changes from $12.23 to $16.57 (Leverage = 0.35)
Scenario 3: Filter COGS reduces from 2.05 to 1.50
LTV changes from $12.23 to $16.47 (Leverage = 1.29)
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Lifetime Value of Customers
Case 3: A Credit Card Issuer
The issuer was evaluating a marketing campaign
(direct mail acquisition)
Total costs: HK$5900 per thousand mailings
Average gross revenue per responder: $500 / first year
Operating Costs: 40%, so net revenue: $300 per
responder in the first year
Response rate: 1%, so acquisition cost = 5900 / 10 =
$590 customer
Ratio of acquisition cost / net revenue = 1.97, so this
campaign was deemed a failure.
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The following table captures a 4-year LTV as a function of
annual revenue, assuming discounting of 15% and attrition of 20%
Now the acquisition cost / net revenue = 590 /1258 * 60% = 0.78
The company could use this analysis in 2 ways:
1) Segment by LTV and spend more on high LTV customers
2) Segment by acquisition cost / net revenue and eliminate customer
types for whom this ratio is likely to be > 1.
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Case 4: Calculating LTV without scrupulous fidelity
George: Buys once a month, Contribution $10
Most recent purchase from Store A
Transition Matrix: What is the probability of a second
event conditional on a previous event?
This time
A
70%
30%
50%
50%
Last Time
70%
30%
50%
50%
70%
What is the expected value of Store As
LTV arising from a customer (George)?
Approach: Treat the customer as a gamble
70%
30%
Period 1:
0.70 x 10
Period 2:
A
30%
50%
50%
(0.70 x 0.70 + 0.30 x 0.50) x 10
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Case 4: The Value of Financial Planning
Number of Products
Life
Annual Contribution
Cost to Serve
No plan (A)
Plan (B)
3
4
$20
$15
4
5
$20
$15
1) What is the value of a financial plan?
2) A = $100, Cost of plan = $50, Only half the customers
become Type B customers. What is the value of a
customer?
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Marketing Analysis: Our Roadmap
Overview: Customer Value Management (CVM)
Quantifying
Value
Calculating Acquisition Cost
Lifetime Value of Customer
Which Value to Use?
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Gnoons and Tpeezez
Gnoons have a higher LTV and a longer life
Suppose you have capacity constraints, you can
only serve a certain number of customers at a time
$163
$128
$284
Gnoon
$327
Tpeeze
LTV is a good criterion, but other factors may assume importance!
Things to keep in mind while doing LTV
analysis
1) Clearly identify all relevant costs and revenues
2) Categorize them as one-time or ongoing
3) Identify the life of the customer and calculate LTV
using the present value of the future stream
4) Use sensitivity analysis to answer questions like:
What happens if I double the customer life?
How much can I spend on trying to increase annual
consumption?
What is the impact of a cost increase on customer LTV?
Calculate leverages to estimate the best course of action
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