Business Intelligence/ Decision Models Lifetime Value
Firm Worth The selling price of a firm is based on discounted future profits. Future profits are generated by customers and by customer acquisition The firm equity aggregated from individual customer equity (customer value)
How Lifetime Value is used for acquisition and retention We need to know the value (the equity) of our customers, for sales targeting and retention efforts We need to discriminate among customers to acquire and retain the best More specifically, how much money should be spent on Acquisitions Retention
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.
Customer Lifetime Value n CLV = [NPV Σ i= 1 (Pr i X Inc i )] – AC 0 where Pr is the survival probability for period i Pr X Inc. is the expected income for period I n is the number of time periods NPV is the net present value AC is the acquisition cost
Simple CLV Spreadsheet http://www.dbmarketing.com/articles/Art251a.htm Acquisition YearSecond YearThird Year Customers100,00060,00042,000 Retention Rate60%70%80% Orders per Year1.82.53 Avg Order Size$90$95$100 Total Revenue$16,200,000$14,250,000$12,600,000 Costs %70%65% Cost of Sales$11,340,000$9,262,500$8,190,000 Unit Acquisition Cost$35$0 Unit Marketing Cost$20 Marketing Costs$5,500,000$1,200,000$840,000 Total Costs$16,840,000$10,462,500$9,030,000 Gross Profit-$640,000$3,787,500$3,570,000 Discount Factor (1+.16) 0 (1+.16) 1 (1+.16) 2 Discount Factor11.161.35 Net Present Value-$640,000$3,265,086$2,644,444 Cumulative NPV Profit-$640,000$2,625,086$5,269,531 Customer LTV-$6$26$53 Discount Factor = (1 + (.08 x 2)) 2 or D = (1.16) 2 = 1.35.
How much to invest in retention? During Year 2 Pr. of cancelling = 30% Replacement Cost: $35.00 * 30% = $10.50 Gross profit if surviving: $3,787,500/60,000 = $63.13 Opportunity Cost if cancelled: $63.13 x 30% = $18.94 Total Expected Cost: $18.94 + $10.50 = $29.44 If 100% sure to salvage, investment < $29.44 If only 10% probability of salvage, investment < $2.94
Discount Rate First year (0): (1+.06) 0 = 1.0 Second year : (1+.06) 1 = 1.060 Third year : (1+.06) 2 = 1.124 _________________________________ PV = FV in p0 $100/1 = $100 PV = FV in p1 $100/1.06 = $94 PV = FV in p2 $100/1.124 = $89 NPV over all three years =$283
Getting Starting Values Calculate tenure or LOF (Dte Lst Purchase – Dte Frst Purchase) Calculate Recency (Current Dte – Dte Lst Purchase) Define Status (Active/Lapsed) Recode Recency if <> X into 0 or 1 Calculate annual spending by Tenure Average annual spending or Average orders X Average order size Cost per acquisition Total acquisition cost / Acquired numbers
Life Tables Run Life Tables By Tenure chunks (Months or Years) By Status (Terminal Event) By Customer Segment Run compare means DV Average Order, Average Spending IV Tenure chunks (Months or Years)
Tutorial This week Program a CLV Worksheet (See Excel sheet) Next week Use SPSS to Estimate CLV a) Use Survival/Life table to estimate cumulative survival rate by time period and customer segment b) Use Compare Means to estimate annual purchases c) Transfer data into your CLV spreadsheet