To estimate CLV we need two pieces of information - customer profit patterns and their defection...

  

Transcribed Image Text:

To estimate CLV we need two pieces of information - customer profit patterns and their defection rate. The profit pattern is the profit (margin) generated from a customer over their tenure with the firm In the beginning, a firm spends money to acquire a customer. For example, credit card companies spend money on direct mail to acquire business customers. The typical response rate for these direct mail offers is 1-2%. Also, not everyone who responds to the offer qualifies for a credit card. Therefore, even if the cost of sending one piece of direct mail is only a few cents, the eventual cost to acquire one customer can amount to $40. Once the customer starts using the credit card the company obtains profit from the customer. Figure 1 shows the flow of costs and profits from this customer. Al Profit (5) $131.00 $100.00 SM00 300.00 500.00 $31.00 $0.00 -430.00 -$41.00 -$40.00 $42.00 Figure 1 Customer Profit Pattern 100.00 5.00 HI 43LL $86.00 392.00 $10.00 39.0 400m Car Tre(Year) A simple way to compute the long term value of this customer is to add all profits over the length of the data, here nine years: $42 + $66 + $70+...+$105 = $731. However, this ignores the time value of money-that is, $100 today is worth more than $100 next year. In order to account for the time value of money a discount rate must be applied. 1. Using a 8% discount rate, compute the present value of the profits shown in Figure 1. Thus far we have assumed that the customer stays with the firm for nine years. However, it is unreasonable to expect that if we acquire 100 customers in year 0 that we will still have all 100 customers in year 9. Customers defect for a variety of reasons, including poor service, better competitive offers, or changes in needs and preferences. Therefore, the actual value of 100 customers is likely to be much less than 100 times the amount you calculated in #1 above. In order to account for customer defection the defection pattern of our customers must be known. Figure 2 shows this defection pattern. Figure 2 120 100 Customer Delection Patter This defection pattern suggests that of the 100 customers acquired in year 0, only 82 are left at the end of year 1. In other words, 18 customers defected. Of these remaining 82 customers, 6 customers defected the next year leaving 76 customers at the end of year 2, and so on. Note that we are tracking the same cohort (group) of customers over time. 2. Compute the present value of the cohort of customers using the annual profits from Figure 1, a 8% discount rate, and the customer defection patterns in Figure 2. 3. 4. Knowing that it cost the credit card firm $40 to acquire each customer, compute the total acquisition cost for all customers. Using the present value of the cohort of customers computed in #2 (above) and the total acquisition cost for all customers computer in #3 (above), calculate the expected net present value of these customers to the company. To estimate CLV we need two pieces of information - customer profit patterns and their defection rate. The profit pattern is the profit (margin) generated from a customer over their tenure with the firm In the beginning, a firm spends money to acquire a customer. For example, credit card companies spend money on direct mail to acquire business customers. The typical response rate for these direct mail offers is 1-2%. Also, not everyone who responds to the offer qualifies for a credit card. Therefore, even if the cost of sending one piece of direct mail is only a few cents, the eventual cost to acquire one customer can amount to $40. Once the customer starts using the credit card the company obtains profit from the customer. Figure 1 shows the flow of costs and profits from this customer. Al Profit (5) $131.00 $100.00 SM00 300.00 500.00 $31.00 $0.00 -430.00 -$41.00 -$40.00 $42.00 Figure 1 Customer Profit Pattern 100.00 5.00 HI 43LL $86.00 392.00 $10.00 39.0 400m Car Tre(Year) A simple way to compute the long term value of this customer is to add all profits over the length of the data, here nine years: $42 + $66 + $70+...+$105 = $731. However, this ignores the time value of money-that is, $100 today is worth more than $100 next year. In order to account for the time value of money a discount rate must be applied. 1. Using a 8% discount rate, compute the present value of the profits shown in Figure 1. Thus far we have assumed that the customer stays with the firm for nine years. However, it is unreasonable to expect that if we acquire 100 customers in year 0 that we will still have all 100 customers in year 9. Customers defect for a variety of reasons, including poor service, better competitive offers, or changes in needs and preferences. Therefore, the actual value of 100 customers is likely to be much less than 100 times the amount you calculated in #1 above. In order to account for customer defection the defection pattern of our customers must be known. Figure 2 shows this defection pattern. Figure 2 120 100 Customer Delection Patter This defection pattern suggests that of the 100 customers acquired in year 0, only 82 are left at the end of year 1. In other words, 18 customers defected. Of these remaining 82 customers, 6 customers defected the next year leaving 76 customers at the end of year 2, and so on. Note that we are tracking the same cohort (group) of customers over time. 2. Compute the present value of the cohort of customers using the annual profits from Figure 1, a 8% discount rate, and the customer defection patterns in Figure 2. 3. 4. Knowing that it cost the credit card firm $40 to acquire each customer, compute the total acquisition cost for all customers. Using the present value of the cohort of customers computed in #2 (above) and the total acquisition cost for all customers computer in #3 (above), calculate the expected net present value of these customers to the company.

Answer rating: 100% (QA)

1 Using an 8 discount rate we can compute the present value of the profits shown in Figure 1 as follows PV 421081 661082 701083 1051089 PV 33375 So the present value of the profits from this customer ... View the full answer