Pricing Executive Summary

Week 04 Acquisition and Customer Lifetime Value (CLV)

https://www.smh.com.au/politics/federal/nbn-customers-face-higher-prices-or-poorer-internet-connection-audit-warns-20190813-p52go7.html

Customer Relationship Management?

CRM is the process of carefully managing detailed information about individual customers and all customer touch points to maximize customer loyalty.

Now closely associated with data warehousing and mining

Relationship

Relationship

Identifying good customers: RFM Model

Recency

Frequency

Monetary Value

Time/purchase occasions since the last purchase

Number of purchase occasions since first purchase

Amount spent since the first purchase

R

F

M

Total RFM Score: R Score + F score + M Score

CASE: Database for BookBinders Book Club

Predict response to a mailing for the book, Art History of Florence, based on the following variables accumulated in the database and the responses to a test mailing: Gender Amount purchased Months since first purchase Months since last purchase Frequency of purchase Past purchases of art books Past purchases of children’s books Past purchases of cook books Past purchases of DIY books Past purchases of youth books

Recency Frequency

Monetary

Example: RFM Model Scoring Criteria

R

Months from last purchase

13-max 10-12 7-9 3-6 0-2

Score 5pts 10 15 20 25

F

Frequency > 30 21-30 16-20 11-15 0-10

Score 25pts 20 15 10 5

M

Amount purchased

> 400 301-400 201-300 101- 200  100

Score 50 45 30 15 10

Implement using Nested If statements in Excel

Decile Classification

• Standard Assessment Method • Apply the results of approach and

calculate the “score” of each individual • Order the customers based on “score”

from the highest to the lowest • Divide into deciles • Calculate profits per deciles

Customer 1 Score 1.00 Customer 2 Score 0.99

…. Customer 230 Score 0.92

Customer 2300 Score 0.00

Decile1

Decile10

… ..

… ..

Output for Bookbinders club Decile Score RFM No. of Mailings Cost of mailing RFM Units sold RFM Profit

10 17.6% 5000 $3,250 783 $4,733

20 34.8% 10000 $6,500 1,543 $9,243

30 46.1% 15000 $9,750 2,043 $11,093

40 53.4% 20000 $13,000 2,370 $11,170

50 65.2% 25000 $16,250 2,891 $13,241

60 77.9% 30000 $19,500 3,457 $15,757

70 83.3% 35000 $22,750 3,696 $14,946

80 91.7% 40000 $26,000 4,065 $15,465

90 97.5% 45000 $29,250 4,326 $14,876

100 100.0% 50000 $32,500 4,435 $12,735

Note: Market Potential = 4435 units and margin = $10.20

Leaky bucket

New customer acquisition

Purchase increase by current customers

Purchase decrease by current customers

Lost customers

Lost customers

Credit Card Rewards Programs Have Had a Direct Impact on Lowering Churn

Rewards Cards and Card Attrition

Reward Card Penetration

Industry Attrition Rate

% o

f cr

ed it

c ar

d h

o ld

er s

w it

h

re w

ar d

s ca

rd

2000 2002 2003 2004 20052001

0%

10%

20%

30%

40%

50%

60%

80%

70%

cred it card

attritio n

35%

30%

25%

20%

15%

10%

5%

0%

Source: Celenet Analysis

40%

50% 56%

62%

69%

45%

Reward Card Penetration

Card Industry Attrition Rates

30%

26%

24%

21%

29% 28%

Customer Lifetime Value (CLV) “present value of a stream of revenue a customer produces”

Focus on long-term relationship, not a single transaction

relationship value

cost savings

price premium

demand increase

base profit

acquisition cost Time

A n

n u

al P

ro fi

t

CLV: Customer Lifetime Value

Total Lifetime Value of

Customer

Economic Value:

(Risk Adjusted) Revenue Flow Less Cost-to-Serve

Relationship Value:

Reference Referral Learning Innovation, etc.

Economic Lifetime Value Calculation

(Expected) Cost to Serve Cash Flow

Expected Profit Cash Flow

Risk Adjustment

Risk Adjusted Cash Flow

(minus)

Loyalty

(Expected) Revenue Cash Flow

 Lowers

 Lowers

CLV calculation (finite lifetime)

• Assume a few parameters re a customer • She generates revenue, R and costs C amount of marketing, support and

service each period. Then, her margin is (R - C) per each period. Note that R and C may change across periods.

• She has a probability of staying with the company, p, i.e., retention rate and churn rate of (1-p).

• Discount rate is r and initial acquisition cost is AC. • She stays with the company for the next N periods (e.g., years).

• Then, her CLV becomes

CLV calculation (Infinite lifetime)

• Assume that a customer stays with the company for an infinite economic life, i.e., .

• Also assume that R and C are relatively fixed across periods.

• Then, her CLV becomes

Example CLV calculation

• Assume two customer segments

Frequent Buyer Occasional Buyer

Acquisition Cost (AC) $17.50 $17.50

Service Cost (C) $6 $2 (first period $6)

Revenue (R) $20 $16

Discount Rate (r) 10% 10%

Retention Rate (p) 75% 50%

Break-Even Analysis

Frequent buyers become profitable in two (2) years whereas Occasional buyers become profitable in three (3) years

Period 1 2

Revenue $20 $20

Retention Rate 100% 75%

Service Cost $6 $6

Profit Margin $14.00 $10.50

Cumulative (net of AC) ($3.50) $7.00

Period 1 2 3

Revenue $16 $16 $16

Retention Rate 100% 50% 25%

Service Cost $6 $2 $2

Profit Margin $10.00 $7.00 $3.50

Cumulative (net of AC) ($7.50) ($0.50) $3.00

Frequent Buyers Occasional Buyers

CLV for frequent buyer

Period 1 2 3 4 5 6 7 8 9 10

Revenue $20 $20 $20 $20 $20 $20 $20 $20 $20 $20

Survival Rate 100% 75% 56% 42% 32% 24% 18% 13% 10% 8%

Service Cost $6 $6 $6 $6 $6 $6 $6 $6 $6 $6

Profit Margin $14.00 $10.50 $7.88 $5.91 $4.43 $3.32 $2.49 $1.87 $1.40 $1.05

Discount Rate 10% 10% 10% 10% 10% 10% 10% 10% 10% 10%

Discount Factor 0.91 0.83 0.75 0.68 0.62 0.56 0.51 0.47 0.42 0.39

Discounted margin $12.73 $8.68 $5.92 $4.03 $2.75 $1.88 $1.28 $0.87 $0.59 $0.41

Cumulative (net of AC) ($4.77) $3.90 $9.82 $13.86 $16.61 $18.48 $19.76 $20.63 $21.23 $21.63

CLV for infinite lifetime = $ $ . .

CLV for Occasional buyer

Period 1 2 3 4 5 6 7 8 9 10

Revenue $16 $16 $16 $16 $16 $16 $16 $16 $16 $16

Survival Rate 100% 50% 25% 13% 6% 3% 2% 1% 0% 0%

Service Cost $6 $2 $2 $2 $2 $2 $2 $2 $2 $2

Profit Margin $10.00 $7.00 $3.50 $1.75 $0.88 $0.44 $0.22 $0.11 $0.05 $0.03

Discount Rate 10% 10% 10% 10% 10% 10% 10% 10% 10% 10%

Discount Factor 0.91 0.83 0.75 0.68 0.62 0.56 0.51 0.47 0.42 0.39

Discounted margin $9.09 $5.79 $2.63 $1.20 $0.54 $0.25 $0.11 $0.05 $0.02 $0.01

Cumulative (net of AC) ($8.41) ($2.62) $0.01 $1.20 $1.74 $1.99 $2.10 $2.15 $2.18 $2.19

𝐶𝐿𝑉 = $16 − $2

1 − 0.5 + 0.1 − $17.50 −

$16 − $2 1 + 0.1

− $16 − $6

1 + 0.1 = $2.2

• CLV analysis allows firms to understand the potential value of customers and prompt firms to learn more about the patterns of individuals or groups of customers. The firms can

• devise optimal strategies for each customer, • eliminate wasteful costs, • create a long-term perspective of potential relationship with customers, • tailor strategies to deal with different customer segments that exhibit

differences in buying characteristics at any given time, and • customize different strategies for the same customer depending on the stage

of relationship between the customer and the firm.

Benefits of CLV analysis

• “Firing” Customers • Raise prices for the less profitable products. • Best customers typically outspend others considerably, with a ratio of 15 to 1

in some industries. • Rewarding Customers

• Discount vouchers or preferential services for best customers • Identifying Cross-Selling Opportunities

• With detailed information about the interests and shopping patterns • Forecasting Innovation Value

• Understand the long-term profitability of an innovation • CLV can be combined with product diffusion model

Strategic Implications of CLV analysis

Blue Ocean Strategy, if time permits

• Virgin Mobile Case (Workshops) • Case report is due at 3pm on Friday, 23 August. • Submit an electronic copy via Turnitin on UTSOnline

• NO Lecture unless demanded

Next week