Business Intelligence/
Decision Models
Week 4
Lifetime Value
Review

Week 2: Data organization in RDBMS, SQL
Queries

Week 3: Importing data into SPSS and Data
Transformation in preparation for analytics
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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 i
Pr X Inc. is the expected income for period I
n is the number of time periods
NPV is the net present value
AC is the acquisition cost
LTV
Spreadsheet
 Life tables (SPSS)

Simple CLV Spreadsheet
Customers
Retention Rate
Orders per Year
Avg Order Size
Total Revenue
Acquisition
Year
100,000
60%
1.8
$90
$16,200,000
Second
Year
Third
Year
60,000
70%
2.5
$95
$14,250,000
42,000
80%
3
$100
$12,600,000
70%
$11,340,000
$55
$5,500,000
$16,840,000
65%
$9,262,500
$20
$1,200,000
$10,462,500
65%
$8,190,000
$20
$840,000
$9,030,000
Gross Profit
Discount Factor
Net Present Value
-$640,000
1
-$640,000
$3,787,500
1.16
$3,265,086
$3,570,000
1.35
$2,644,444
Cumulative NPV Profit
Customer LTV
-$640,000
-$6
$2,625,086
$26
$5,269,531
$53
Costs
Cost of Sales
Acquisition/Mkt. Cost
Marketing Costs
Total Costs
Discount Factor = (1 + (.08 x 2))2 or D = (1.16)2 = 1.35.
http://www.dbmarketing.com/articles/Art251a.htm
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
=
1.0
Second year : (1+.06)1
= 1.060
Third year : (1+.06)2
= 1.124
_________________________________
PV = FV in p0
$100/1
= $100
PV = FV in p1
$100/1.06 = $94
PV = FV in p2
$100/1.124 = $89
NPV 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 Spreadsheet
Starting Parametres
Period
Year
Acquisitions
Retention
Oders per year
Avg Oder Size
Margin
Accquisition Cost
Marketing Cost
Annual Discount Rate
0
1
2
1
2
3
100,000
60%
1.8
$90
70%
$35
$20
16%
70%
2.5
$95
65%
80%
3
$100
65%
$20
16%
$20
16%
Tutorial
1.
2.
Program a CLV Worksheet (See Excel
sheet)
Use SPSS to Estimate CLV
a)
b)
c)
Use Survival/Life table to estimate
cumulative survival rate by time period and
customer segment
Use Compare Means to estimate annual
purchases
Transfer data into your CLV spreadsheet