Business Intelligence/ Decision Models Week 4 Lifetime Value

Review Week 2: Data organization in RDBMS, SQL Queries Week 3: Importing data into SPSS and Data Transformation in preparation for analytics Week 4: Customers’ Lifetime value CLV Spreadsheets SPSS Life Tables and Means Estimating CLV from SPSS and into Excel

How Lifetime Value is used for acquisition and retention We need to know the value (the equity) 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 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

LTV Spreadsheet Life tables (SPSS)

Simple CLV Spreadsheet AcquisitionSecondThird Year Customers100,00060,00042,000 Retention Rate60%70%80% Orders per Year Avg Order Size$90$95$100 Total Revenue$16,200,000$14,250,000$12,600,000 Costs70%65% Cost of Sales$11,340,000$9,262,500$8,190,000 Acquisition/Mkt. Cost$55$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 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: $ $10.50 = $29.44 If 100% sure to salvage, investment < $29.44 If only 10% probability of salvage, investment < $2.94

NPV (Corrected) 10% = $1.10 (after 1 yr) 10% = $1.21 (after 2 yrs) $1 x (1.10) 3 = $1.33 (after 3 yrs) FV = PV x (1 + r) n PV = FV/(1 + r) n

Discount Rate First year (0): (1+.06) 0 = 1.0 Second year : (1+.06) 1 = Third year : (1+.06) 2 = _________________________________ 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

Excel for discounting factor Discount Rate = (1 + r)^n Discount Rate = POWER((1+r),n)

Discount Rate Discount Rate for period 1 (r): Interest Rate (e.g. 10%) Cost of Capital (e.g. 15%) Hurdle Rate (e.g. ROI = 20%)

Simple CLV Spreadsheet Starting Parametres Period0 12 Year123 Acquisitions 100, Retention60%70%80% Oders per year Avg Oder Size$90$95$100 Margin70%65% Accquisition Cost$35 Marketing Cost$20 Annual Discount Rate 16%

Tutorial 1. Program a CLV Worksheet (See Excel sheet) 2. 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