Project Idea from MRKT 350 (courtesy Dwayne Ball)
Our Imaginary Enterprise:
Wonderful Wines of the World
Wonderful Wines of the World (WWW) is a 4-year-old enterprise that seeks out small,
unique wineries around the world and brings their wines to its customers. Its mission is to
delight its customers with well-made, unique, and interesting wines that would otherwise
never travel far beyond their points of origin.
WWW sells wines through catalogs and a web site. Customers can purchase by telephone
(after looking at the catalog), or on the web site. Over one hundred selections are available
in each new catalog, sent every 4 months. The entire selection over the past 4 years has been
200 different wines, some of which have been out-of-stock at one time or another.
Through aggressive promotion in wine and food magazines, WWW now has 300,000
customers in its database. Most customers are highly involved in wine, entertain frequently,
and have sufficient money to indulge their passion for wine.
WWW is trying to make use of the database it started about 4 years ago. So far, it has simply
mass-marketed everything. All customers get the catalog every 91 days beginning with their
first order, and there are no loyalty programs or attempts to identify target markets for crossselling opportunities. Now, WWW wants to “get smart” about its database, and start
differentiating customers, and developing more focused programs.
WWW has provided two sample datasets of 10,000 people from its database. These are all
customers who have purchased something from WWW in the past 4 years.
COSTS AND PROFITS FOR WWW
A word about the costs and profits for WWW: Nearly all costs - the cost of buying,
shipping, storing, normal mass advertising costs, and the cost of handling complimentary
calls and letters, are built into the base cost for each bottle of wine – see the wine price file.
There are no options for faster or slower delivery to the customer, at greater or lower cost WWW has negotiated a standard shipping rate per bottle with several major shippers and the
customer should always receive the wine in 3-4 days from the order (although sometimes,
due to errors made by WWW’s shipping department, bottles are late). Handling an order or
complaint over the telephone costs $3, and handling an order over the WWW web site costs
$0.25 (these are called “transaction costs”). The catalog costs $1 to print and mail every 91
days.
A point about complaints: not all people who receive the wrong wine, or a late delivery,
complain about it. Probably, the great majority do not complain. But, it affects the
relationship nonetheless. Those who do complain receive an apology and a $25 coupon for
their next purchase (which is an added cost on top of the $3 it costs to handle the complaint
call or e-mail). The apology and the gift coupon may help the relationship. Thus, each wrong
wine or late delivery costs WWW something on the customer’s satisfaction, value perception,
and loyalty. Each complaint about wrong wines or late delivery costs WWW $28, but may
help the relationship if there are no additional mistakes, because of the effort expended to
mollify the customer.
WWW hopes to make a 25% profit above the costs of each bottle of wine before transaction
costs. That is, if the base cost of a wine is $40 per bottle (including delivery charge), it will
Project Idea from MRKT 350 (courtesy Dwayne Ball)
try to sell it for $50 and make a $10 profit, which is 25% of costs. Another way to look at it
is that 80% of the usual price of each bottle is base costs. However, transaction costs (either
$0.25 or $3), any discounts offered, the costs of the catalog, and any costs of handling
complaints (at $28 per complaint) will further reduce the profits on sales.
For example, let us consider someone who bought 3 times (twice over the telephone and once
on the web) last year, and spent $200, and had an average discount of 15%. Further, let us
assume that he or she complained of a late delivery on one of those three occasions. What
were the costs for that person last year, and what was the percentage of revenues that were
costs?
First, let’s deal with the usual, or “full,” price.
The usual price of the wine is what the customer paid plus their discounts. Now this
customer paid $200, but that was after 15% discounts, so he or she only paid 85% of the
usual price. So, the usual price would be:
Usual price = (what customer paid) / (fraction of the usual price they paid)
Usual price = $200 / 0.85 = $235.29
So, this customer paid $200, but if they had paid full price, they would have paid $235.29.
Now, the base costs are 80% of the usual price, so base costs are:
Base costs = 0.80 * $235.29 = $188.23
But, on top of that we must add transaction costs, catalog costs, and the cost of dealing with
one complaint. So, total costs are:
Base cost of the wine:
$188.23
Two telephone orders
6.00
One Internet order
0.25
Four catalogs that year
4.00
One complaint
28.00
------------------------------------------------Total costs
$226.48
As you can see, it cost WWW $226.48 to serve this customer, who returned in revenue only
$200.00.
As a result, his or her cost percentage is 100 * (total costs) / (total revenues)
Cost percentage = 100 * ($226.48) / ($200.00)
= 113.24%
This customer generates negative profits, because he or she costs more to serve than he or she
returns in revenue. If, on the other hand, he or she had taken no advantage of discounts, and
paid $200 for wines at full price, always ordered on the Internet, and never complained, then
the calculations would look like this:
Project Idea from MRKT 350 (courtesy Dwayne Ball)
Usual price of wines = $200
Base cost = 0.80 * $200 = $160
Cost of 3 Internet transactions = $0.75
Cost of 4 catalogs that year =$4.00
Total costs = $164.75
Cost percentage = 100* $164.75 / $200.00 = 82.4%
That is a profitable customer at close to the hoped-for profit margins – about as close as
WWW will ever get at its current pricing policy.
The cost variables in the database, TOTCCOST (total customer costs over all purchases) and
COSTLAST (total customer costs over the past 365 days) include base costs, discounts,
transaction costs, catalog costs, and the costs of providing coupons because of complaints. In
other words, those variables contain every cost that WWW can account for.
Cost calculations for a segment
So, let’s consider a segment of 30,000 customers with the following data in the MCF:
$360.00
$344.00
$720.00
$690.00
12%
20.0
912.5
10.0
$72.00
60%
0.10
0.10
REVLSTYR average per-customer revenue in the last 365 days.
COSTLAST average per-customer costs in the last 365 days.
TOTCREV average per-customer revenue since first purchase.
TOTCCOST average per-customer costs since first purchase.
AVGDISC average per-customer discount since first purchase.
TBOTTLES average number of bottles purchased per customer since first p.
FIRSTPUR average number of days since first purchase (about 2.5 years)
NPURCH average number of purchases per customer since first purchase.
AVGPURCH average revenue per purchase per customer since first purch.
PERCWEB average per-customer percent of bottles purchased from web.
TOTWCOMP average number complaints per customer about wrong wines.
TOTLCOMP average number of complaints per customer about late wines.
By looking at the numbers, we can see that the average customer in this segment has
increased his or her purchases over the past 2.5 years, since half of all purchases were in the
last 365 days. This fact will be important; we will have to assume that half of all bottles were
purchased, discounts were taken, and complaints were made in the past 365 days. Our
calculations below are, indeed for the past 365 days.
Now, the individuals in this segment currently have a 94.4% cost percentage. WWW is
making a little money on them, but not much. Let’s see why.
First, what is the usual price of the wine they have been purchasing? Well, they have been
getting 12% discounts and paying, over the past year $360.00. Therefore, the full price is:
Project Idea from MRKT 350 (courtesy Dwayne Ball)
Full price of wine = $360 / 0.88 = $409.10
The base cost of the wine they’ve bought is 80% of that, so
Base cost of wine = 0.80 * 409.10 = $327.27
Now, there are other costs in addition to the base cost of the wine. There’s the catalogs,
transaction costs, and taking care of complaints. So, for each customer, on average, those
costs are:
Catalogs every 91 days at $1 each:
$4.00
5 transactions per year (10 transactions as a whole over 2.5 years, but we estimate
half of them in the last 365 days), and of those 60%, or 3 transactions are on the
web and 2 are on the telephone:
3 Internet purchase per year at 25 cent each $0.75
2 telephone purchase per year at $3 each
$6.00
And finally, we would assume that half of all complaints have been logged in the
past year, since half of all purchases have been in the past year. So, that is 0.05
complaints about wrong wines and 0.05 complaints about late wines per customer
per year.
0.05 wrong wine complaints at $28 each
0.05 late wine complaints at $28 each
$1.40
$1.40
So, as you can see, our final calculation of costs is:
$327.27
$ 4.00
$ 6.75
$ 2.80
base costs of wine
cost of catalog
transaction costs
complaint costs
$340.82 total costs for the average customer in this segment.
Now, this is somewhat different from what is in the database, which is $344.00 as total costs.
This is because the averages we are dealing with in the MCF don’t translate perfectly into the
calculations for individuals. That’s OK. The two numbers are close enough that we can see
where the costs are coming from. In project 3, you will be called upon to develop a program
for each of two segments, and the programs will raise or lower the costs for those segments.
So, you should be able to show exactly how, using these types of calculations, how costs will
change under your segment programs.
LIFETIME VALUE FOR WWW
A few points about WWW’s customer lifetime value calculations:
Project Idea from MRKT 350 (courtesy Dwayne Ball)
-
The calculations are done separately for each customer, not by customer groups.
The CLV calculations are carried out for 10 years.
The discount rate used by WWW is 8%.
The revenue and costs used are those from the past year for the given customer.
Retention probability is assumed to be 70% for customers of less than 1 year’s
duration, or customers that have not ordered in the past year. Customers who made
their first purchase between 1 and 2 years ago and have made a purchase in the past
year are assumed to have an 80% retention probability. Customers whose first order
was more than 2 years ago and who have made an order in the past year are assumed
to have a 90% retention probability. WWW has only a weak basis for using these
numbers, not a scientific basis.
WINES AND WINE RATINGS
A word on the company’s wine rating system: ratings of wines range from about 60 to 100.
These are internal company ratings by its own experts and do not correspond to rating
systems by anyone else. A rating of 70 means the wine has significant flaws (too tannic, no
fruit notes, no complexity, too much oak, requires drinking very soon or it will be vinegar,
too sweet for its type, etc.), but is still drinkable. A rating of 100 implies that the wine has no
flaws and is very good (other rating systems might give it a lower number, of course). Wines
in the 90-100 range are generally excellent for their type. The rating system is explained in
the catalog and on-line to the customers, and the rating for each wine is given in the catalog
and web site.
A word on wines, if you are unfamiliar with them: the world of wines is very complex.
Humans have been making wine for thousands of years, ever since someone left some grape
juice in a pot and it fermented. There are tens of thousands of wineries and brands, ranging
from very small wineries that sell only a few hundred bottles per year, to the very large
producers that everyone has heard of. Wines are made all over the world, where growing
conditions make it possible. Traditionally, wine is made from grapes, although what WWW
calls “exotic” wines are made from other fruits, like apples, pears, and so forth. Grapes come
in hundreds of varieties, with a few of the more popular being cabernet (red), pinot noir (red),
shiraz (red), chardonnay (white), pinot grigio (white), and semillon (white). Generally, a red
or black grape can make either a red or white wine, depending on whether the grape skins are
left in the wine during fermentation (taking them out produces a white wine). In any small
region of the world, just a few varieties can be counted on to produce good wines, if any at all
– there are issues of general climate, duration and timing of rainfall and heat, soil
characteristics, harvest timing, production quality, method of fermentation and aging,
bottling, storage, and shipping quality, and so forth. Two wineries on the same hill may
produce very different quality of wines, even though they grow the same grape variety.
Wines the company sells are grossly classified into dry red, semi-dry (or “sweet”) red, dry
white, sweet white, dessert, and exotic wines. The “dryness-sweetness” of a wine refers to its
sweetness on the tongue, and sugar content. Generally, the more sophisticated one’s taste,
the more one will prefer drier wines (sweet wines and exotic wines are considered to be “like
soda pop” to the connoisseur, and only for amateurs or frivolous occasions). However, it is
more difficult to make a dry wine taste good, because it easy for them to become too
“tannic,” or bitter, or to have a flat, and characterless taste unless the winemaker is skilled. In
a dry wine, the lack of sweetness must be compensated for by complexity – faint overtones of
Project Idea from MRKT 350 (courtesy Dwayne Ball)
berries and spices, oak from the aging barrels, just enough tannin to give the wine a little
“bite” on the tongue, and so forth.
Connoisseurs think that a certain wine will be a good accompaniment to certain foods or
occasions, and not to others. For example, it is generally thought that strong-tasting dry red
wines go well with strongly-flavored meats (beef and many game animals), or with food in
strongly-flavored sauces, such as pasta with tomato (marinara) sauce. Connoisseurs will
generally make far finer distinctions regarding the exact nature of the wine that is best for a
particular food, and will often have a separate wine for each course at a formal meal. Semidry or sweet red wines, fruity and served chilled, are often thought to go well with a light
summer meal. Dry white wines are generally thought to go well with fish, chicken, and
perhaps pork. Sweet wines are often considered for before-dinner with hors d’ouvres or as
cocktails, while dessert wines, like port, are often thought of as after-dinner drinks, with nuts
or cigars. Champagne and other sparkling wines (i.e., with carbonation), which WWW does
not sell, are often thought of as celebratory wines, or wines to serve before or after dinner,
although they can be good with some dishes.
The catalog and web site are very simple. Each is divided into sections (dry red wines, semidry red wines, etc.). Each available wine is described (with a picture of the bottle). The
description gives the general characteristics of the wine, information about its place of origin,
its rating number, and price. For example:
Wine 147: Chateau Mad Dog Merlot 2006 is a very well-made dry and low-tannic red
wine with considerable character, and overtones of oak, blueberries, and cinnamon. It
is produced near Avignon, France, by a retired U.S. diplomatic official, James “Mad
Dog” Lawman, who worked for many years in France. The composition is 90%
Merlot grapes and 10% Cabernet Sauvignon. Should be excellent with any beef or
game dish or pasta with red sauce. The chateau produces only about 2500 bottles per
year. Rating: 100. Price: $46.98 per bottle.
The MKIS relational data base consists of a master customer file, transaction file, and wine
price list file.