Pricing and Revenue management

Week 04 Customer Lifetime Value (CLV) calculation exercise

Dr. Kyuseop Kwak

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 𝑅 𝐶 𝑝

1 𝑟 𝐴𝐶

CLV calculation (Infinite lifetime)

• Assume that a customer stays with the company for an infinite  economic life, i.e., 𝑁 → ∞. • Also assume that R and C are relatively fixed across periods.

• Then, her CLV becomes 𝐶𝐿𝑉 𝑅 𝐶 1 𝑝 𝑟 𝐴𝐶

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 $ $ . . $17.50 $22.5

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 2

1 0.1 $2.2