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 Σi=1(Pri X Inci)] – AC0

where Pr is the survival probability for period iPr X Inc. is the expected income for period In is the number of time periodsNPV is the net present valueAC is the acquisition cost

LTV Spreadsheet Life tables (SPSS)

Simple CLV Spreadsheet

http://www.dbmarketing.com/articles/Art251a.htm

  Acquisition Year Second Year Third YearCustomers 100,000 60,000 42,000Retention Rate 60% 70% 80%Orders per Year 1.8 2.5 3Avg Order Size $90 $95 $100Total Revenue $16,200,000 $14,250,000 $12,600,000       Costs % 70% 65% 65%Cost of Sales $11,340,000 $9,262,500 $8,190,000

Unit Acquisition Cost $35 $0 $0Unit Marketing Cost $20 $20 $20Marketing Costs $5,500,000 $1,200,000 $840,000Total Costs $16,840,000 $10,462,500 $9,030,000       Gross Profit -$640,000 $3,787,500 $3,570,000Discount Factor (1+.16)0 (1+.16)1 (1+.16)2

Discount Factor 1 1.16 1.35Net Present Value -$640,000 $3,265,086 $2,644,444Cumulative NPV Profit -$640,000 $2,625,086 $5,269,531Customer 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

NPV

$1 @ 10% = $1.10 (after 1 yr)

$1.10 @ 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 = 1.0Second year : (1+.06)1 = 1.060Third year : (1+.06)2 = 1.124_________________________________PV = FV in p0 $100/1 = $100PV = FV in p1 $100/1.06 = $94 PV = FV in p2 $100/1.124 = $89NPV over all three years =$283

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

Simple CLV Spreadsheet

http://www.dbmarketing.com/articles/Art251a.htm

  Acquisition Year Second Year Third YearCustomers 100,000 60,000 42,000Retention Rate 60% 70% 80%Orders per Year 1.8 2.5 3Avg Order Size $90 $95 $100Total Revenue $16,200,000 $14,250,000 $12,600,000       Costs % 70% 65% 65%Cost of Sales $11,340,000 $9,262,500 $8,190,000

Unit Acquisition Cost $35 $0 $0Unit Marketing Cost $20 $20 $20Marketing Costs $5,500,000 $1,200,000 $840,000Total Costs $16,840,000 $10,462,500 $9,030,000       Gross Profit -$640,000 $3,787,500 $3,570,000Discount Factor (1+.16)0 (1+.16)1 (1+.16)2

Discount Factor 1 1.16 1.35Net Present Value -$640,000 $3,265,086 $2,644,444Cumulative NPV Profit -$640,000 $2,625,086 $5,269,531Customer LTV -$6 $26 $53

 Discount Factor = (1 + (.08 x 2))2    or   D = (1.16)2 = 1.35.

Simple CLV SpreadsheetStarting Parametres

Period 0 1 2

Year 1 2 3

Acquisitions 100,000 - -

Retention 60% 70% 80%

Oders per year 1.8 2.5 3Avg Oder Size $90 $95 $100

Margin 70% 65% 65%

Accquisition Cost $35   

Marketing Cost $20 $20 $20

Annual Discount Rate 16% 16% 16%

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)

TutorialThis weekProgram a CLV Worksheet (See Excel sheet)

Next weekUse 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 purchasesc) Transfer data into your CLV spreadsheet