Customer Relationship Management:A Database Approach

MARK 7397Spring 2007

James D. HessC.T. Bauer Professor of Marketing Science

375H Melcher Hall jhess@uh.edu713 743-4175

Class 6

• Computation of Customer Profitability

• Past Customer Value of a customer

Where i = number representing the customer, r = applicable discount rate

n = number of time periods prior to current period when purchase was made

GCin = Gross Contribution of transaction of the ith customer in the nth time period

• Since products/services are bought at different points in time during the customer’s lifetime, all

transactions have to be adjusted for the time value of money

• Limitations: Does not consider whether a customer is going to be active in the future. Also

does not incorporate the expected cost of maintaining the customer in the future

Past Customer Value

N

1n

nin )r1(*GC

Spending Pattern of a Customer

The above customer is worth $302.01 in contribution margin, expressed in net present

value in May dollars. By comparing this score among a set of customers a prioritization

is arrived at for directing future marketing efforts

Jan Feb March April May$ Amount 800 50 50 30 20

GC 240 15 15 9 6

302.01486 5)0125.01(2404)0125.01(15

3)0125.01(152)0125.01(9)0125.01(6

Scoring ValueCustomer Past

0.3 Amount X Purchase (GC) Contribution Gross

=++++

+++++

=

´=

Lifetime Value metrics (Net Present Value models)

• Multi-period evaluation of a customer’s value to the firm

RecurringRevenues

Recurring costs

Contribution margin

Lifetime of a customer

Lifetime Profit

Acquisition cost

LTV

Discount rate

Calculation of Lifetime Value: Simple Definition

where LTV = lifetime value of an individual customer in $, CM = contribution margin, = interest rate, Rr = retention rate, so Rrt=survival rate for t periods

• LTV is a measure of a single customer’s worth to the firm • Used for pedagogical and conceptual purposes

tT

1tt 1

RrCMLTV

CM1CM2

Rrt

1/(1+)t

0

LTV: Definition Accounting for Acquisition Cost and Retention Probabilities

Where, LTV = lifetime value of an individual customer in $

Rrk = retention rate

П = Product of retention rates for each time period from 1 to T,

AC = acquisition cost

T = total time horizon under consideration

Assuming that T and that the contribution margin CM does not vary over time,

ACCMRrLTVT

tit

t

k

1 1 1

1

t

k

ACRrCMiLTV i

1Rr

Note: many typos on page 127

To Calculate Customer Lifetime Value

1. You must be able to forecast profit contributions

2. You must understand the cost of marketing

3. You must be able to forecast retention rates of customers (since if the customer has abandoned the firm no profits will flow.)

4. It is possible that customers will “churn.” That is, they may leave and then return later.

5. The contribution of a customer may be causally tied to churn andabandonment, making this trickier than it looks.

6. You need to understand NPV calculations.

LTV: Definition Accounting for Varying Levels of Contribution Margin

Where, LTV = lifetime value of an individual customer i in $, S = Sales to customer i, DC = direct cost of products purchased by customer i, MC = marketing cost of customer i

tT

1tititit 1

1MCDCSLTV

Recall the Cell2Cell data from last week

CMi=(67.58+.595*Monthsi-7.615*Marriedi-.046*EqpDaysi)*ContribRate

Abandonment versus Churn:Lost for Good or Missing in Action

States of Customer: S0 = bought this period S-1 = last bought one period before

State Transition (Markov Matrix)Before

S0 S-1

S-1

S0

After0.7

0.3 1.0

0.0= T

Pt=(Pt,0,1-Pt,0)’ Probability that at time t you are in the two states

Lost for Good

Abandonment versus Churn(continued)

BeforeS0 S-1

S-1

S0After

0.7

0.3 1.0

0.0

Pt= T Pt-1

= T T Pt-2

= T T …T P0

Tk =0.7k

1.0

0.0

1-0.7k

This is the type of calculation we did abovewith a retention rate of 70%. However, once gonethe customer never returns.

Abandonment versus Churn:just “Missing in Action”

Before

S0 S-1

S-1

S0

After

0.7

0.3 0.0

0.1

S-2

S-2

0.0

1.0

0.0

0.90.0

If you haven’t bought in two periods, you are gone, but you couldappear and disappear from one period to the next.

Abandonment versus Churn:just “Missing in Action”

.52

.21 .03

.07

0.0

1.0

0.0

0.9.27

T2 =

.38

.16 .02

.05

0.0

1.0

0.0

.93.48

T3 =