Page 293 - DMGT308_CUSTOMER_RELATIONSHIP_MANAGEMENT

Customer Relationship Management

Notes The average customer recruits 3 other customers. The maximum acquisition cost of a new
customer should be 4 x $19.20 = $76.80 to breakeven.
The sum of your entire customer Lifetime Values should equal your future profits; if you
include the value of pass-a-long customers in Lifetime Value, you will over estimate profits.
Don’t be surprised if you find some customer groups have negative LTV’s – it’s very common.
This is the part of LTV analysis usually forgotten, because it literally means you would be more
profitable if you had fewer customers. And explaining that to your boss (if you have one) is
often a challenge, even on a positive day.
Most models to calculate CLV apply to the contractual or customer retention situation. These
models make several simplifying assumptions and often involve the following inputs:

1. Churn Rate: The percentage of customers who end their relationship with a company in a
given period. One minus the churn rate is the retention rate. Most models can be written
using either churn rate or retention rate. If the model uses only one churn rate, the
assumption is that the churn rate is constant across the life of the customer relationship.
2. Discount Rate: The cost of capital used to discount future revenue from a customer.
Discounting is an advanced topic that is frequently ignored in customer lifetime value
calculations. The current interest rate is sometimes used as a simple (but incorrect) proxy
for discount rate.

3. Retention Cost: The amount of money a company has to spend in a given period to retain
an existing customer. Retention costs include customer support, billing, promotional
incentives, etc.
4. Period: The unit of time into which a customer relationship is divided for analysis. A year
is the most commonly used period. Customer lifetime value is a multi-period calculation,
usually stretching 3-7 years into the future. In practice, analysis beyond this point is
viewed as too speculative to be reliable. The number of periods used in the calculation is
sometimes referred to as the model horizon.
5. Periodic Revenue: The amount of revenue collected from a customer in the period.
6. Profit Margin: Profit as a percentage of revenue. Depending on circumstances this may be
reflected as a percentage of gross or net profit. For incremental marketing that does not
incur any incremental overhead that would be allocated against profit, gross profit margins
are acceptable.

Did u know? After measuring customer value, the next step is to manage customer value–
to make money by creating very high ROI customer marketing campaigns and site designs.
The Drilling Down book describes how to easily create future value and likelihood to
respond scores for each customer, and provides detailed instructions on how to use these
scores to continuously improve the profitability of your customers.
Uses of Lifetime Value

Lifetime Value is typically used to judge the appropriateness of the costs of acquisition of a
customer. For example, if a new customer costs $50 to acquire (CPNC, or Cost per New Customer),
and their lifetime value is $60, then the customer is judged to be profitable, and acquisition of
additional similar customers is acceptable. For this reason, the costs involved in the first purchase
are typically not included in LTV, but rather, in the Cost per New Customer calculation.

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