Business Intelligence/Decision Models

Week 4Lifetime Value

Review Week 2: Data organization in RDBMS, SQL

Queries

Week 3: Importing data into SPSS and Data Transformation in preparation for analytics

Week 4: Customers’ Lifetime value CLV Spreadsheets SPSS Life Tables and Means Estimating CLV from SPSS and into Excel

How Lifetime Value is used for acquisition and retention We need to know the value (the equity) of our

customers, so as to properly target our sales and retention efforts

We need to discriminate among our 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 Second Third

Year Year 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

Acquisition/Mkt. Cost $55 $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 1.16 1.35Net Present Value -$640,000 $3,265,086 $2,644,444

Cumulative 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 (Corrected)

$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)

Discount Rate http://en.wikipedia.org/wiki/Discounting

Discount Rate for period 1 (r): Interest Rate (e.g. 10%) Cost of Capital (e.g. 15%) Hurdle Rate (e.g. ROI = 20%)

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%

Tutorial

1. Program a CLV Worksheet (See Excel sheet)

2. Use SPSS to Estimate CLVa) Use Survival/Life table to estimate

cumulative survival rate by time period and customer segment

b) Use Compare Means to estimate annual purchases

c) Transfer data into your CLV spreadsheet