Page 250 - DMGT522_SERVICES MANAGEMENT

Unit 11: Customer Loyalty

11.6.3 Lifetime Value of a Customer Notes

A fundamental concept of Customer-relationship Management is the lifetime value of a new
customer. The basic idea is that customers should be judged on their profitability to the firm
over the total time they make purchases. Profitability is usually based on net value, that is, the
mark-ups over cost less the cost of acquiring and keeping the customer. Fixed costs are not
considered because it is assumed that these costs will be incurred with or without the particular
customer.
This presents a simple method of doing the calculations. It is based on the average customer and
does not consider the time value of money or the effects of marketing actions such as loyalty
programs and referral programs.

Approach

The simplest approach to lifetime value is to compute the average net revenue by multiplying
four quantities together:
Avg. sale * No. of purchases/year * Stay of customer * Average Profit %

Example:
Consider a stationery store serving small corporate clients: Average sale – ` 2,000
Number of purchases/year – 2
Expected length of customer stay (years) – 3
Average profit margin – 24%

Thus the Lifetime net revenue: ` 2,880
Having the net revenue, the lifetime value can be determined by subtracting acquisition and
retention costs:
Lifetime value = Lifetime revenue – Cost to acquire – (Cost to retain × No. of purchases) If, for
example, the allocated cost to an acquired customer from an advertisement is ` 500 and the cost
to retain the customer for each purchase after the first one is ` 20 then:

Net lifetime value of customer = 2880 – 500 – (20 × 5) = ` 2,280
Three strategies can be followed to increase the value of the customer:
1. Increase size of average sales (tie-ins, package multiple items).
2. Increase the number of sales (find other customer-needs you can provide and satisfy them
with).
3. Increase profit margin (reduces overhead costs, reduce cost of goods and raise price if
market will stand it).

A more sophisticated calculation would probably include retention rates (per cent of customers
who buy again), discount rates, effect of loyalty programs, average annual purchase per customer
(including increasing number of sales and increasing amount per sale to retained customers),
mark-up of goods, cost to obtain a new customer, cost per year to maintain a customer, cost to
obtain customers through referrals, risk factor (that the customer will not pay), delay between
order and payment (i.e., the account receivable days), repurchase cycles, etc.
All of these considerations would need to be factored in a lifetime value model depending on
the industry and company where CRM is to be implemented.

LOVELY PROFESSIONAL UNIVERSITY 245