University of Washington EMBA Program Regional 20

University of Washington EMBA ProgramRegional 20 “Lifetime Value Analysis” T.A.: Rory McLeod

Lifetime Value of a Customer • The net present value (less the cost of customer acquisition) that you will receive from transactions with a given customer during the time that you expect this customer to continue to buy from you. • Can help you make marketing strategy decisions: • If an investment increases lifetime value, do it! • If an investment decreases lifetime value, don’t! • Often the benefits of a marketing investment do not come in the first year. This does not make it a bad investment!

Lifetime Value of a Customer • Sophisticated corporations today look further than NPV when trying to assess a customer or customer segments’ Lifetime Value. • In fact, a substantial portion of the customer’s “true” value to the organization can stem from referrals, network effects, and reduced service costs that are not part of “ basic” LTV calculations. • Through the use of relational databases, marketers can append to an individual’s file the value of profit from referrals. This therefore gives a truer picture of the value of a customer and gives permission to spend accordingly to protect this asset.

Ways to Increase Lifetime Value • Increase the retention rate • Increase the referral rate • Increase the spending rate • Decrease the direct costs • Decrease the marketing costs

What is the proper computation period? • Which is the correct lifetime value? 1, 2, 3, 4, 5 or more years? • They are all correct. Which you use depends on your product or service. • Long lifetimes: banks, insurance, utilities, automobiles • Short lifetimes: discount houses, package goods, catalogers

Example: Mary Anne’s Closet • Mary Anne’s Closet is a small chain of stores offering children’s clothing to 100,000 customers. They decide to track 10,000 customers. • The following information is provided: • Retention Rate = 30% • Average customer spends $120 / year • Cost of goods sold (COGS) is 70% of revenue • Current market rate of interest is 8%. They decide to double this number to 16% to account for risk.

Table 10-1. Mary Anne’s Closet

The Discount Rate • A dollar today is worth more than a dollar in the future. • To convert future profits into today’s money, a discount rate is used. • The discount rate is based on the market rate of interest, plus risk. D = (1 + i)n, where i = interest rate (inc. risk) n = number of years (or periods) • To find the present value of a profit, simply divide that profit by the discount rate.

Table 10-1. Mary Anne’s Closet

Table 10-1. Mary Anne’s Closet 1. $360,000 + $93,103 2. (1) / 10,000 3. 3,000 * .3 4. $120 * (3) 5. 0.7 * (4) 6. (4) – (5) 7. (6) / 1.35 8. (1) + (7) 9. (8) / 10,000

Mary Anne’s Closet’s Birthday Club • Mary Anne’s Closet has decided to try to increase customer lifetime value by starting a birthday club, which will include: • A 20% discount coupon for any card-carrying-customer buying a present for a child with a birthday that month • “Happy Birthday” balloons as a gift for any birthday child that comes into the store • A small gift to reward referrals • Following are revised assumptions: • Retention Rate = 50% • Referral Rate = 8% • Average customer spending rate = $150 / year

Table 10-2. Mary Anne’s Closet with the Birthday Club Assumptions: 1. Assume referrals buy in Year 2. 2. $5 per customer: mailing & balloons. 3. Average of $4 discount per customer 4. No referrals in Year 1. 5. Referral rate of 8 percent times Year 1 total customers. 6. Retained customers plus referred customers.

Net Change in Customer Lifetime Value (Assume half of the store’s 100,000 customers participate.)

Thank You!

University of Washington EMBA Program Regional 20