Acquisition Value and Customer Lifetime Value As the local Time Warner manager, you are considering two promotional campaigns, one targeting new students and the other targeting new faculty at SMU. The promotion includes free installation and set-up for new accounts. You normally charge $20 for setting up a new account, which barely covers the variable costs for installation, regardless of the type of service. To qualify for free installation, customers have to agree to a 12-month contract. Most students purchase the basic package at $20 per month but most faculty purchase the HDTV package for $50 per month. Variable cost is $10 per month for basic and $20 for HDTV. To encourage students to upgrade to the HDTV package, you will offer them 3 months of HDTV for just $30, with the price changing to the normal $50 after the first 3 months. You think that 50% of the new student accounts will take advantage of this offer. There are 3,000 new students and 200 new faculty at SMU every year. The student promotional campaign will yield a 20% acquisition rate and the faculty promotional campaign will yield a 50% acquisition rate. To target the 2 groups, you will have to buy mailing lists and generate a direct mail campaign. What is the most you would spend per acquired customer for the promotional campaign if you want a three-month payback? Six-month payback?

Students – Basic Students- HDTV Faculty 1. Total number of customers targeted 3, Acquisition rate 20%50% 3. Total # of customers acquired (#1 × #2, student split 50-50) 4. First-quarter contribution per month (i.e., Price – VC) 5. Number of monthly purchases (first quarter) First-quarter gross contribution (#3×#4×#5) 7. Minus installation & set-up costs ($20 × #3) 8. First-quarter net contribution (#6-#7) 9. First quarter net contribution per acquired customer (#8/#3) $9,000 $6,000 $2,000 $3,000 $7,000 $10 $70 Three-month payback: $10 & $70 Six-month payback? $70 (.5 * * 100) per student and $160 (70+90) per faculty member.

To promote the campaign, you will spend $10 per targeted student and $20 per targeted faculty. You want to calculate the lifetime value of each new student and faculty customer using first-year expected contribution. Expected retention rates and risk factor (associated with students skipping out without paying and stealing the equipment) for the 3 customer groups are shown below. Is the HDTV upgrade offer worthwhile? What is the total increase in the firm’s customer equity?

Students - Basic Students- HDTV Faculty 10. First-year per-customer gross contribution 11. Per-customer acquisition costs (AC) to promote + install 12. Retention rate (r)40%20%70% 13. Discount rate (i)10% 14. Risk factor CLV infinite lifetime = CM/(i* r) – AC $120$300$360 $70 $ Total number of each type of customer 17. Increase in customer equity = where i* = i × risk factor. $80$203$ $24,000$60,818$84,000 12×$103×$10+9×$3012×$30 ($10×3000)/600 + $20 ($20×200)/100 + $20 - $70 $ $ $70 $ $60

You are the product manager for the new Mountain Man Lite beer. Research results are in for the new positioning strategy, which targets year-old, men and women. In the region, there are 10,000,000 people in this demographic, beer penetration is 20%, and beer drinkers consume 50 gallons per year on average. Research indicates the following response to the new positioning strategy. Past experience indicates that adjusted trial rates are 80% for respondents indicating they “Definitely would try…” and 30% for respondents indicating they “Probably would try…” You worked up numbers for two advertising & promotion (A&P) campaigns. The $2,000,000 campaign focuses on a pull strategy, using advertising to build awareness among the target market. With this campaign, 20% of the target market will be aware of MM Lite. Using the current sales staff to promote the MM Lite to current retail customers, you expect to achieve 40% distribution coverage. The $3,000,000 campaign implements the same pull strategy but also implements a push strategy that includes trade promotions and point-of-sale merchandising. These efforts will increase distribution coverage to 50% but will likely have little additional impact on target customer awareness. Two product concepts have also been tested. One concept remains true to the “bitter flavor and slightly higher-than- average alcohol content” that differentiates Mountain Man Lager, the flagship beer. Taste tests indicate that target customers respond fairly well to this concept and that 50% would retry the product. Target customers respond more positively to the second concept, which offers a smoother taste and average alcohol content, suggesting that 60% would retry the product. Trial purchase volume is estimated to be 1 gallon and repeat purchase volume is estimated at 10 gallons per year. Pricing for both products will be around $10 per gallon. The COGS for the “Bitter Flavor” concept will be $7.50 per gallon, the same as the MM Lager COGS. COGS for the “Smooth Taste” concept would be $8.00 per gallon, because it requires different ingredients than those currently used. Product development expenses, which were $2,000,000, are treated as sunk costs. Assuming that awareness and distribution coverage targets apply for the entire first year, what is the first-year unit volume sales forecast (in gallons) for the first year for each option? Definitely would try MM Lite20% Probably would try MM Lite30%

2MM Promotion, Bitter Flavor 2MM Promotion, Smooth Taste Research Results Adjusted Trial Awareness % Coverage % Penetration % Trial Rate % # Trial Buyers Repeat % # Repeat Buyers Repeat Volume Unit Volume Trial + Repeat Definites 20%80%20%40%20% 10 Probables 30%30%20%40%20% 10 $2MMPromotion& BitterFlavor Total UnitVolume-> XXXX=.256% 10,000,000 25,60050%12, ,000 25,600 + Research Results Adjusted Trial Awareness % Coverage % Penetration % Trial Rate % # Trial Buyers Repeat % # Repeat Buyers Repeat Volume Unit Volume Trial + Repeat Definites 20%80%20%40%20% 10 Probables 30%30%20%40%20% 10 $2MMPromotion& BitterFlavor Total UnitVolume-> XXXX=.144% 14,40050%7,200 72,000 14,400 + XXXX=.256%25,60060%15, ,600 25,600 + XXXX=.144%14,40060%8,640 86,400 14, ,600 86, , , , ,800

3MM Promotion, Bitter Taste 3MM Promotion, Smooth Taste Research Results Adjusted Trial Awareness % Coverage % Penetration % Trial Rate % # Trial Buyers Repeat % # Repeat Buyers Repeat Volume Unit Volume Trial + Repeat Definites 20%80%20%40%20% 10 Probables 30%30%20%40%20% 10 $3MMPromotion& BitterFlavor Total UnitVolume-> XXXX=.320%32,00050%16, ,000 32,000 + XXXX=.180% 18,00050%9,000 90,000 18, , , ,000 Research Results Adjusted Trial Awareness % Coverage % Penetration % Trial Rate % # Trial Buyers Repeat % # Repeat Buyers Repeat Volume Unit Volume Trial + Repeat Definites 20%80%20%50%20% 10 Probables 30%30%20%50%20% 10 $3MMPromotion& BitterFlavor Total UnitVolume-> XXXX=.320%32,00060%19, ,000 32,000 + XXXX=.180%18,00060%10, ,000 18, , , ,000

What are revenue and contribution margin forecasts for the first year? Assuming the A&P campaign is a fixed cost for the first year only (i.e., not recurring after the first year) and revenues are stable, at what point will MM Lite break even under the best scenario? Which option would you choose and why? Options Market Share Market SizeUnit Volume Revenue Forecast COGSContributionReturn on A&P $2MM Bitter 100,000,000 $2MM Smooth 100,000,000 $3MM Bitter 100,000,000 $3MM Smooth 100,000, , , , ,000.24%.28%.30%.35% 2,400,000 2,800,000 3,000,000 3,500,000 1,800,000 2,240,000 2,250,000 2,800, , , , ,000 30% 28% 25% 23% $7.50 $8.00 $7.50 $8.00

Channel Pricing & Required Volume to Breakeven Altius’s Victor TX golf balls currently retail at $40 per dozen. Golf ball sales have been steady at 20 million dozens per year but Altius’s market share has decreased over the last few years from 50% to 40%. As the manager for the golf ball product line, you are considering one of two strategies to recapture share: (1) decrease the retail price for TX by 5% to $38 for a dozen, or (2) introduce a new, lower-priced XX ball that will compete at the $25 retail price point. Retailers expect a 20% margin on all golf balls. Complete the table below to determine the unit profit implications of a $2 decrease in the retail price for TX, assuming the gross margin is currently 70%, and the unit contribution for Victor XX, assuming a gross margin of 60%? Victor TX$2 Price decreaseVictor XX Retail price $40$38$25 Retailer margin 20% Victor price Victor variable cost Victor unit contribution Victor gross margin 70%60% $32.00$30.40$ % * 32 =$22.40 $9.60  $9.60 $20.80$12.00 $8.00

Complete the table below to determine current gross profit and the break-even market share and unit volume for the $2 retail price decrease option. Total Unit VolumeVictor TX Market ShareVictor TX Unit VolumeVictor TX Gross Profit 20,000,00040%8,000,000 BE %   BE Share & Volume — $  P $CM’ + $  P BE %  = You believe that Altius could recapture 5 market share points (to 45%) by introducing the XX ball, but it would result in an additional 5 point drop in share for TX; in other words, TX would capture 35% share and XX would capture 10% share. Complete the table below to determine the gross profit implications. Total MarketVictor TXVictor XX Combined Gross Profit 100%35%10% Unit Volume20,000,000 Victor unit contribution Gross Profit % 43.1%8,615,385 7,000,0002,000,000 $12.00$22.40 $156,800,000$24,000,000$180,800,000

You also believe the $2 price decrease on TX balls would recapture 5 market share points (to 45%) without introducing the XX ball. Complete the table below to determine the gross profit implications. Total MarketVictor TX Market Share100%45% Unit Volume20,000,000 Victor unit contribution Gross Profit Which option would you choose and why? $187,200,000 $ ,000,000

Questions?