1. Customer Relationship Management: A Database Approach MARK 7397 Spring 2007 James D. Hess C.T. Bauer Professor of Marketing Science 375H Melcher Hall jhess@uh.edu 713 743-4175 Class 6

2. Computation of Customer Profitability Past Customer Value of a customer Where i = number representing the customer, r = applicable discount rate n = number of time periods prior to current period when purchase was made GC in = Gross Contribution of transaction of the i th customer in the n th time period Since products/services are bought at different points in time during the customer’s lifetime, all transactions have to be adjusted for the time value of money Limitations: Does not consider whether a customer is going to be active in the future. Also does not incorporate the expected cost of maintaining the customer in the future Past Customer Value

3. Spending Pattern of a Customer The above customer is worth $302.01 in contribution margin, expressed in net present value in May dollars. By comparing this score among a set of customers a prioritization is arrived at for directing future marketing efforts JanFebMarchAprilMay $ Amount80050 3020 GC24015 96 302.01486 5 )0125.01(240 4 )0125.01(15 3 )0125.01(15 2 )0125.01(9).01(6 Scoring ValueCustomerPast 0.3 Amount X Purchase (GC) Contribution Gross =++++ +++++ = ´=

4. Lifetime Value metrics (Net Present Value models) Multi-period evaluation of a customer’s value to the firm Recurring Revenues Recurring costs Contribution margin Lifetime of a customer Lifetime Profit Acquisition cost LTV Discount rate

5. Calculation of Lifetime Value: Simple Definition where LTV = lifetime value of an individual customer in $, CM = contribution margin,  = interest rate, Rr = retention rate, so Rr t =survival rate for t periods LTV is a measure of a single customer’s worth to the firm Used for pedagogical and conceptual purposes t T 1t t 1 Rr CMLTV           CM1 CM2 Rr t 1/(1+  ) t 0

6. LTV: Definition Accounting for Acquisition Cost and Retention Probabilities Where, LTV = lifetime value of an individual customer in $ Rr k = retention rate П = Product of retention rates for each time period from 1 to T, AC = acquisition cost T = total time horizon under consideration Assuming that T   and that the contribution margin CM does not vary over time, ACCMRrLTV T t it t k                      1 1 1 1  t k AC Rr CM i LTV i     1 Rr Note: many typos on page 127

7. To Calculate Customer Lifetime Value 1.You must be able to forecast profit contributions 2.You must understand the cost of marketing 3.You must be able to forecast retention rates of customers (since if the customer has abandoned the firm no profits will flow.) 4.It is possible that customers will “churn.” That is, they may leave and then return later. 5.The contribution of a customer may be causally tied to churn and abandonment, making this trickier than it looks. 6.You need to understand NPV calculations.

8. LTV: Definition Accounting for Varying Levels of Contribution Margin Where, LTV = lifetime value of an individual customer i in $, S = Sales to customer i, DC = direct cost of products purchased by customer i, MC = marketing cost of customer i

9. Recall the Cell2Cell data from last week

11. CM i =(67.58+.595*Months i -7.615*Married i -.046*EqpDays i )*ContribRate

16. Abandonment versus Churn: Lost for Good or Missing in Action States of Customer: S 0 = bought this period S -1 = last bought one period before State Transition (Markov Matrix) Before S0S0 S -1 S0S0 After 0.7 0.31.0 0.0 = T P t =(P t,0,1-P t,0 )’ Probability that at time t you are in the two states Lost for Good

17. Abandonment versus Churn (continued) Before S0S0 S -1 S0S0 After 0.7 0.31.0 0.0 P t = T P t-1 = T T P t-2 = T T …T P 0 T k = 0.7 k 1.0 0.0 1-0.7 k This is the type of calculation we did above with a retention rate of 70%. However, once gone the customer never returns.

18. Abandonment versus Churn: just “Missing in Action” Before S0S0 S -1 S0S0 After 0.7 0.30.0 0.1 S -2 0.0 1.0 0.0 0.9 0.0 If you haven’t bought in two periods, you are gone, but you could appear and disappear from one period to the next.

19. Abandonment versus Churn: just “Missing in Action”.52.21.03.07 0.0 1.0 0.0 0.9.27 T 2 =.38.16.02.05 0.0 1.0 0.0.93.48 T 3 =