MARK 7397
Spring 2007
Customer Relationship Management:
A Database Approach
Class 6
James D. Hess
C.T. Bauer Professor of Marketing Science
375H Melcher Hall
jhess@uh.edu
713 743-4175
Past Customer Value
•
•
Computation of Customer Profitability
Past Customer Value of a customer

N
n
GC
*
(
1

r
)
 in
n 1
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
Spending Pattern of a Customer
$ Amount
GC
Jan
Feb
800
50
240
15
March
April
May
50
30
20
15
9
6
Gross Contribution (GC) = Purchase Amount X´ 0.3
Past Customer Value Scoring =
6 (1 + 0 .0125 ) + 9 (1 + 0 .0125 )
2+
3
15 (1 + 0 .0125 )
+ 15 (1 + 0 .0125 ) 4 + 240 (1 + 0 .0125 ) 5 = 302.01486
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
Lifetime Value metrics
(Net Present Value models)
• Multi-period evaluation of a customer’s value to the firm
Recurring
Revenues
Recurring
costs
Contribution
margin
Lifetime of a
customer
Lifetime Profit
LTV
Discount
rate
Acquisition
cost
Calculation of Lifetime Value: Simple Definition
 Rr 

LTV
 CM t  1   
t 1
T
t
Rrt
CM1
CM2
1/(1+)t
0
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
LTV: Definition Accounting for
Acquisition Cost and Retention Probabilities
Note: many typos on page 127
T
LTV 

t 1
t


 1 
  Rr CM it 
 - AC
k
1  
 k1 
t
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,
LTV i

CMi Rr
- AC
1 - Rr  
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 and
abandonment, making this trickier than it looks.
6. You need to understand NPV calculations.
LTV: Definition Accounting for
Varying Levels of Contribution Margin
T
 1 
LTV   Sit - DC it - MC it 

1




t 1
t
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
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
S0
0.7
Lost for Good
0.0
=T
After
S-1
0.3
1.0
Pt=(Pt,0,1-Pt,0)’ Probability that at time t you are in the two states
Abandonment versus Churn
(continued)
Before
S0
S-1
After
S0
0.7
0.0
S-1
0.3
1.0
Pt= T Pt-1
= T T Pt-2
= T T …T P0
Tk =
0.7k
0.0
1-0.7k
1.0
This is the type of calculation we did above
with a retention rate of 70%. However, once gone
the customer never returns.
Abandonment versus Churn:
just “Missing in Action”
Before
After
S0
S-1
S-2
S0
0.7
0.1
0.0
S-1
0.3
0.0
0.0
S-2
0.0
0.9
1.0
If you haven’t bought in two periods, you are gone, but you could
appear and disappear from one period to the next.
Abandonment versus Churn:
just “Missing in Action”
T2 =
T3 =
.52
.07
0.0
.21
.03
0.0
.27
0.9
1.0
.38
.05
0.0
.16
.02
0.0
.48
.93
1.0