customer relationship management- crm 3.pdfcustomer relationship management- crm day 3: measuring...

drvkumar.com© Dr. V Kumar 1

Dr. V KumarRichard and Susan Lenny Distinguished Chair Professor of Marketing,

Executive Director, Center for Excellence in Brand & Customer Management,

Director of the Ph.D. Program in Marketing

J. Mack Robinson College of Business

Georgia State University

Customer Relationship Management- CRM

Day 3: Measuring and Maximizing Customer Lifetime Value (Part I)


Customer Loyalty and CLVMeasuring CLV (Contd.)

drvkumar.com© Dr. V Kumar

Case Study – Revenue Analyses“Wyndham ByRequest” Member versus Non-member comparisons

Q1 2001 Q2 2001 Q3 2001 Q4 2001

New Members added 25,000 50,000 55,000 50,000

Members

Total nights 104,491 119,624 127,505 141,669

Total stays 36,116 40,554 45,049 46,197

Total guests 26,616 30,811 35,433 36,955

Total revenue

produced

$12,403,161 $14,090,471 $15,099,372 $14,830,528

Rev/member 466.00 457.31 426.13 401.31

Non-members

Total nights 1,548,501 1,918,634 1,429,460 1,040,763

Total stays 406,536 441,865 392,469 338,459

Total guests 352,977 383,051 336,263 291,399

Total revenue

produced

$163,294,362 $164,863,345 $130,685,357 109,404,522

Rev/Non-member 462.62 430.39 388.64 375.45

3


Co-relation Between Guest Membership,Loyalty and Revenues

• Only 1 in 5 Guests across business, conference and leisure segments return to Hilton because of program membership in a given year

• Wyndham spent approximately US $ 50 Million in FY 2001 to attract 180,000 new members to ―Wyndham ByRequest‖ Loyalty Program

Did Wyndham’s aggressive campaign result in proportional increase in retention and revenue?

4


Brand Preferences and Business Travel Decision Process

Hotel Selection Decision Elements

Influential in %

2002 2001 2000 1999

Location 91 89 83 86

Previous experience with hotel 89 94 84 86

Value for the price 82 86 76 72

Reputation of hotel/chain 82 80 74 71

Room rate 72 81 75 62

Recommendation of friend/associate 69 70 68 68

Likelihood of upgrade to better accommodation 63 N/A N/A N/A

Brand name 59 53 62 66

Gives both airline mileage and points 51 52 N/A N/A

Airline mileage 37 44 26 25

Recommendation of travel agent 34 35 40 34

Frequent-guest points 29 42 31 26

5

Source – The YP&B Yankelovich Partners National Business Travel Monitor (2000 and 2002)


Total Membership/Program Characteristics by Brand

6

Brand program Established Total

MembersC

How Points

are Earned

based on

Dollar Value

Approximate

Number of

Participating

Properties

Number of

Points

redeemed for

Free Three-Day

Vacation D

Marriott

Rewards

1983 15.5 10 points per

dollar spent A

2,100 50,000

Starwood

Preferred Guest

1986 15 2 points per

dollar spent B

700 21,000

Hilton HHonors 1987 12.7 10 points per

dollar spent

2,100 65,000

Hyatt Gold

Passport

1987 10 5 points per

dollar spent

363 36,000

A – Only room rate at Courtyard, Fairfield Inn and Springhill Suites

B – 3 points for higher-status members

C – In millions

D – Estimated Source - HBR

Dollars Spent

for Free

Three- Day

Vacation

5,000

10,500

6,500

7,200


Segmenting Customers Based On Past And Future Profitability

7

Rising Stars

ACTION:

- Invest to deepen relationship

- Identify specific up-sell / cross-sell opportunities

- Cultivate attitudinal loyalty

True Loyalists

ACTION:

- Cultivate attitudinal loyalty

- Invest to nurture / defend / retain

- Reward proactively

Total Misfits

ACTION:

- No relationship investment

- Aim to extract profit from every transaction by

migrating the customer to low cost channels

Falling Angels

ACTION:

- Identify specific up-sell / cross-sell opportunities

- Transact through low-cost channels

- Optimize (Minimize) Marketing costs

Historical Profits

(PCV)

Fu

ture

Pro

fita

bilit

y

(CLV

)

Low High

Low

High


The Managerial Implications

• Understand loyalty diversity and profitability diversity

• Manage loyalty and profitability simultaneously

• Make forward-looking customer investment

decisions, including projected customer profitability

8


Customer Loyalty and CLV

9


Customer Lifetime Value (CLV)

DEFINITION

• Customer lifetime value is defined as the sum of cumulated cash

flows—discounted using the Weighted Average Cost of Capital

(WACC)— of a customer over his or her entire lifetime (three years in

most cases) with the company.

11

Approach to Measurement

Recurring

Costs

Recurring

RevenuesNet

Margin

Expected Number

of Purchases over

next 3 years

Accumulated

Margin

Acquisition

Costs

Customer

Lifetime

Value- X

-

Gross

Contribution

Margin

Marketing

Costs-


E

N

H

A

N

C

E

D

D

A

T

A

C

O

L

L

E

C

T

I

O

N

C

U

S

T

O

M

E

R

&

S

U

P

P

L

Y

S

I

D

E

F

A

C

T

O

R

S

IMPROVED

ACQUISITION

IMPROVED

RETENTION

Dynamic

Customer

Management

Based on

CLV

IMPROVED

SHAREHOLDER

VALUE

CLV For Better Customer Management & Improved Shareholder Value


Why CLV?

• Forward looking metric unlike other traditional measures (that include past contributions to profit).

• Helps marketers to adopt the right marketing activities ‗today‘ to increase ‗future‘ profitability.

• It can be used to include prospects, not just current customers.

• It is the only metric that incorporates into one, all the elements of revenue, expense and customer behavior that drive profitability.

• It enforces the focus on the customer (instead of products) as the driver of profitability.

13


Understanding the different components of CLV

14


Gross Contribution Margin (GC)

15

Gross Contribution

Margin (GC)

Revenue obtained

from a customer

in a given purchase

Cost of goods

sold=

_


Marketing Costs (M)

Development and Retention costs

- costs of programs to increase the value of existing relationships

- costs of loyalty or frequent buyer programs

- costs of campaigns to ‗win back‘ former customers

- costs of servicing customer accounts

16

Time period (i)

This refers to the natural "lifetime" of customers

For most businesses, it is reasonable to expect customers to return for many

years (‗N‘ number of years).


Discount Rate (d)

• Profits you receive from your customers come in over several years

• Money received in future years is not worth as much today as money received today.

• To estimate the value of future money, we must discount it by a certain percentage.

• This equates the future money to current profits.

17

What is a good discount rate?

- Depends on general interest rate.

- Normally proportional to the treasury bill rate.

- In other words proportional to the interest that banks pay on savings

accounts.


CLV Measurement Scenarios

Scenario 1

• One Purchase per Year

• Eg:

Scenario 2

• Multiple Purchases per Year

• Eg:

18


Measuring Customer Lifetime ValueCase I- P&C Insurance Company

19

td )1(

trN

1t*M-GC CLV

•Sales take place once a year

•Annual allocation of marketing resources

•Customer Retention rate common over time

•Revenues per customer constant over time

N = Planning horizon in years

GC = Annual gross contribution margin.

M = Marketing costs per year.

d = Annual discount rate (appropriate for marketing investments).

r = Annual retention rate


Measuring Customer Lifetime ValueCase I- P&C Insurance Company

20

10

1]})2.1/()75[(.{*000,5000,26

tCLV

tt

= $34,681.00

Numerical Example

Consider an online insurance company trying to estimate CLV for a

customer base of 1000 customers.

Annual promotional expense = $5,000

Annual retention rate = 75%

Planning period = 10 years

Annual Gross Contribution = $26,000

Discount rate = 20%


• Non-Contractual Setting

• Multiple Purchases per year

• Information available on past revenues

• Decision to invest in the relationship depends on – Is the agent still active?

– Is the relationship profitable?

21

Measuring Customer Lifetime ValueCase II – Independent Agents

tT

ditACt

itAlivePi

GC

1

1*

1)( of NPV

ACit = Average gross contribution margin in year t based on all prior purchases

d = discount rate

i = agent

t = current time period

T is the number of years

P(Alive) is the probability that agent i is active


24.127$81.5543.71

)12.1/1(*100*7.0)12.1/1(*100*8.0

1

1*

1)( of NPV

21

2

t

ditACt

itAlivePiGC

Measuring Customer Lifetime Value (Contd.)Case II – Independent Agents

t

ditACt

itAlivePi

GC

1

1*

1)( ofNPV

2

ACit = 100 for Year 1 and 100 for year 2

d = discount rate (12% on a yearly basis)

i = agent

Number of years = 2

P(Alive) is the probability that agent i is active = 0.8 for year 1 and 0.7 for year 2.


Are there any limitations with this approach?

23


• Non-Contractual Setting

• Multiple Purchases per year

• Information available on past purchase behavior, revenues,

and channels of contact made to distributor

• Decision to allocate resources depends on

– How active is the customer?

– Which channel is the most receptive channel for the customer?

– Does the revenue from the customer offset the marketing

investments?

24

Measuring Customer Lifetime ValueCase III – Individual Customer Level


Measuring Customer Lifetime ValueCase III – Individual Customer Level

CLV= NPV of GC – NPV of Marketing Cost

• Since purchases can occur multiple times within a year, the gross contribution from sale is discounted to present value as is occurs

• Similarly, as the marketing cost gets expended, it is discounted to PV

• The costs are computed for each channel using the frequency of contacts in each channel and the unit cost of contact in each channel

• The future periods considered, say three years, could include multiple purchase occasions


i

i

T

t frequencyt

ti

d

GC

1

,

1

Measuring Customer Lifetime Value (Contd.)Case III – Individual Customer Level

NPV of Gross

Contribution

Margin

Where:

GCi,t = Gross contribution margin from customer i in purchase occasion t

frequencyi = 12/expinti,

expinti = expected inter purchase time for customer i

d is the discount rate for money

Ti is number of purchases made by distributor i, until the end of the planning period

• Since purchases can occur multiple times within a year, the gross contribution from sale is discounted to present value as it occurs



NPV of

Marketing Cost

Where:

ci,m,l = unit marketing cost, for customer i in channel m in time period l

xi,m,l = number of contacts to customer i in channel m in time period l


n is the number of years to forecast, and

l

lmilmimn

l d

xc

)1(

* ,,,,

1

• The costs are computed for each channel using the frequency of contacts in each channel and the unit cost of contact in each channel


.

)1(

*

1

,,,,

11

,

l

lmilmimn

l

T

t frequencyt

ti

itd

xc

d

GCCLV

i

i

28

Where,

CLV = Customer Lifetime Value

GCi,t = Gross contribution from customer i in purchase occasion t






n is the number of years to forecast, and

Ti is number of purchases made by distributor i, until the end of the planning period

GC Marketing Cost



)}15.1

20*3()25*3()

15.1

15*60()10*60{(

15.1

2380

15.1

3100

15.1

2200

15.1

200025.115.0

i

CLV

29

.

)1(

*

11

,,,,

11

,

l

lmilmimn

l

T

t frequencyt

ti

id

xc

d

GCCLV

i

i

Let us consider for customer i:

Prediction window (l) = 2 years

Frequency of purchase = 2 purchases per year

Unit cost of salesperson = $60

No. of sales contacts by salesperson = 10 in year 1 & 15 in year 2

Unit cost of telesales = $3

No. of contacts through telesales = 25 in year 1 & 20 in year 2

Interest (Discount) Rate = 15%

= $6583

Measuring Customer Lifetime Value (Contd.)

Case III – Individual Customer Level


Measuring CLV- Summary

• Contractual Vs. Non-contractual

• Single Vs. Multiple Purchases per year

• Calculation of retention rate

• Predict customer activity

• Calculation of gross contribution margin

30


CUSTOMER LIFECYCLE :

•Measurement/

Forecasting

•ROI

•Shopping Basket

•Measurement

•Prediction

•Purchase Sequence

•Enrichment

•Customer Loyalty Programs

•Forecasting

•Prevention

•Win back

OPTIMAL RESOURCE ALLOCATION

Product/Service Call MgmtMarCommPricing

Return on Marketing Investments

Acquisition Retention Attrition

Value

Time

Strategic

Impact

Traditional CLV Curve

Can we influence this graph?


Where do we go from here?

32


Case StudyImplementing the CLV metric

33


Background

• Fashion retailer having retail stores across USA

34

Develop a suitable metric to

measure and manage customer level

profitability

Identify the right metric to manage

customer loyalty

Challenges


Step 1: Identifying the Drivers of Loyalty

35

The retailer used several measures to identify loyal customers:

- Regularity of Purchase

- Frequency of Purchase

- Tenure

Regularity Frequency RFM Tenure

CLV r= - 0.09 r= 0.17 r= 0.19 r= 0.44

N 172,688 470,932 470,932 470,932

Question: Do these measures of loyalty drive profitability?

Result:

Except for tenure, the traditional metrics of loyalty showed poor correlation with loyalty.


Step 2: Measuring CLV

36

Where:

GCi,t = Gross contribution from customer i in purchase occasion t





r = the discount rate for money

n = is the number of years to forecast

Ti = total number of purchases made by customer i

The lifetime value is computed for each customer using this formula:

.

)1(

*

11

,,,,

11

,

l

lmilmim

n

l

T

t frequencyt

tiit

r

xc

r

GCMCLV

i

i


Step 3: Scoring & Segmenting the Customers

37

Customers are rank-ordered into deciles and

segmented based on the distribution of CLV across the deciles

297

92

1

1690

(16) (29) (104)(6)22.356

-200

0

200

400

600

800

1000

1200

1400

1600

1 2 3 4 5 6 7 8 9 10

Decile based on CLV

($)

High CLV

Medium CLV Low CLV


Step 4: Identifying the drivers of CLV

38

Top Drivers of CLV

$ Spent in other channels (Multi-channel shopping) (+)

Tenure (+)

$ Spent in Product A (+)

Cross-Buying (+)

$ Spent in Product B (+)

Lifetime Returns (∩)

Amount of Returns ($)

CLV

Score

($)

X

B


Step 5: Interpreting The Impact of The Drivers

39

Lifetime Returns

$ Spent on Product B

Cross-Selling

$ Spent on Product A

Tenure

$ Spent in

other channels

A 15% increase in cross-channel spending by customers in the top 2 CLV

deciles results in 31% increase in their CLV for PRC stores.

Similar interpretation holds for the remaining variables illustrated below.

31%

14%

12%

11%

4%

-3%

-5% 0% 5% 10% 15% 20% 25% 30% 35%

% Change in CLV


Step 6: Profile Analyses

Develop profile analyses for the High and Low CLV Customers

Gender: Female

Age: 35-54 years

Marital Status: Married

Presence of Children

Estimated Household

Income: $125,000+

Stays closer to retailer

Loyalty Card Member

Mail Order Shopper

Shops frequently in

upscale stores

Typical High CLV Customer

Gender: Male

Age: 25-34 years

Marital Status: Single

Presence of no children

Estimated Household

Income: < $50,000

Stays further away from

retailer

Not necessarily a Loyalty

Card Member

Single Channel Shopper

Typical Low CLV Customer


Step 7: Measuring Store Profitability

41

Store

Store

Revenue ($)

Revenue

Rank

Expected store

profitability

based on CLV

Profitability

Rank

1 20,196,138 1 3,304,942 4

2 11,870,392 2 1,731,856 9

3 9,761,732 3 -4,471,439 14

4 8,705,402 4 7,635,066 1

5 6,487,945 5 2,579,805 7

6 6,314,190 6 -5,816,329 15

7 5,085,694 7 4,660,984 2

8 4,510,125 8 2,759,272 6

9 4,357,225 9 2,526,916 8

10 4,311,662 10 3,577,310 3

11 4,189,061 11 185,066 12

12 3,880,850 12 1,031,893 11

13 3,856,373 13 1,117,543 10

14 3,777,840 14 3,053,192 5

15 3,757,544 15 -348,419 13


Firm Value

42

Firm Level

Store Level

Customer

Level

Product

Level


CLV Based Marketing Strategies


The Wheel of Fortune Strategies Used for Maximizing CLV

Acquiring

Profitable

Customers

Customer

Selection

Preventing

Attrition of

Customers

Referral

Marketing

Strategy

Linking Investments in

Branding to

Customer Profitability

Pitching the Right Product,to the

Right Customer, at

the Right Time

Managing Loyalty and

Profitability

Simultaneously

MEASURING& MAXIMIZING

CUSTOMER

LIFETIME VALUE

Linking CLV to Shareholder

Value

Product

Returns

Future of

Customer

Management

Cross - Buy

Source: Kumar, V., “Managing Customers for Profits”, The Wharton School Publishing

Optimal

Allocation of

ResourcesManaging

Multi-channel

Shoppers

Interaction

Orientation


Customer Selection

To detect and target

customers/distributors based

on their value potential as

opposed to other traditional

metrics.

At the least, ROI is doubled.

45

Objective: Marketing Metric Outcome:


“The top 15 to 20 percent of a bank's customers

represents 130 to 200 percent of the bank's

bottom line profitability."

The First Manhattan Consulting Group

December 1997

46


An Empirical Illustration Showing How CLV Outperforms Other Customer Selection Metrics

47

% of

Cohort

(Selected

from

top)

Using the first 30 months of data to predict the next 18 months of purchase

behavior

Customer Lifetime

Value

Share of Wallet RFM PCV

5 Average

Revenue

489,541 255,885 308,698 357,265

Gross Profit 146,862 76,766 92,609 107,719

Variable Costs 1,270 620 1,051 790

Net Profit 145,592 76,146 91,558 106,389

10 Average

Revenue

265,664 105,394 185,557 186,124

Gross Profit 79,699 31,618 55,667 55,837

Variable Costs 751 588 775 610

Net Profit 78,948 31,030 54,892 55,227

*The reported values are in dollars and are cell medians. Gross profit is residual revenue after

removing cost of goods sold. In general for the firm that provided the database, the cost of

goods sold is around 70%. Hence gross profit is equal to revenue*0.3.


CLV Outperforms All Customer Selection Metrics

48

Summary of gains

Customer

Selection (Top 5% of cohort)

Increase in Net Profits

per customer(Calculated using the first 30 months of

data to predict the next 18 months of

purchase behavior)

Total increase in

Net Profits(For 2000 customers)

Break-even The cost of developing Lifetime

Value model (about $500K) can be

easily recovered from increase in net

profits from less than:

Lifetime Value

Versus SOW

$69,446 $139 Million 8 customers

Lifetime Value

Versus RFM

$54,034 $108 Million 10 customers

Lifetime Value

Versus LTD

$39,203 $78.4 Million 13 customers



Acquiring

Profitable

Customers

Customer

Selection

Preventing

Attrition of

Customers

Referral

Marketing

Strategy


Branding to



Right Customer, at

the Right Time


Profitability

Simultaneously


CUSTOMER

LIFETIME VALUE


Value

Product

Returns

Future of

Customer

Management

Cross - Buy


Optimal

Allocation of

ResourcesManaging

Multi-channel

Shoppers

Interaction

Orientation


Managing Loyalty And Profitability Simultaneously

Segmentation based

approach to guide marketing

actions to loyal

customers/distributors.

Efficient allocation of resources

resulting in increase in

profitability.

50



“55% of consumers who rate their primary

financial institution high on service quality report

they are „very likely‟ to consolidate their business

with one provider.”

- Study by Peppers & Rogers Group,

Financial Service Marketing Magazine

& Roper Starch, 2002.

51


Evolving Dominant Logic in Customer Loyalty

52

1 RFM = Recency, Frequency & Monetary Value; PCV = Past Customer Value; SOW = Share of Wallet.

9

8

7

6

5

4

3

2

1

No

ExtensiveMinimalTechnology & Analytics

usage

CLVRFM, PCV, SOW1Metrics used

Link loyalty to profitability,

Influence behavioral loyalty,

Cultivate attitudinal loyalty

Build market share, increase

revenues, Build behavioral loyalty

through repeat purchase or usage

Program Objective

Tangible + ExperientialTangibleReward Type

Reactive + ProactiveReactiveReward Mechanism

Multiple (usually made possible through

partners and alliances)

Minimal Reward Options

Personalized and relevant, aimed at influencing

specific behavioral change or attitudinal

gratification

Standard and uniform aimed at

repeat purchase

Rewarding Scheme

Customized, based on type of usage or type of

spend

Standardized, based on usage or

spend

Program Type

Customer levelAggregate levelOperationalization Level

Evolving Loyalty Programs:

Customer Centric

Earlier Loyalty Programs:

Program Centric

Dimension


Managing Loyalty & ProfitabilityRethink Customer Segmentation

53

BUTTERFLIES

•Good fit of company offering and

customer needs

•High profit potential

•Action:–Aim to achieve transactional satisfaction, not

attitudinal loyalty

–Milk the accounts as long as they are active

–Key challenge: cease investment once

inflection point is reached

STRANGERS

•Little fit of company offering and customer

needs

•Lowest profit potential

•Action: –No relationship investment

–Profitize every transaction

BARNACLES

•Limited fit of company offering and

customer needs

•Low profit potential

•Action: –Measure size and share-of-wallet

–If share-of-wallet is low, specific up and cross-

selling

–If size of wallet is small, strict cost control

TRUE FRIENDS

•Good fit of company offering and

customer needs

•Highest profit potential

•Actions: –Consistent intermittently spaced

communication

–Achieve attitudinal and behavioural loyalty

–Delight to nurture/defend/retain

High

Profitability

Low

Profitability

Short-term

Customers

Long-term

Customers



Acquiring

Profitable

Customers

Customer

Selection

Preventing

Attrition of

Customers

Referral

Marketing

Strategy


Branding to



Right Customer, at

the Right Time


Profitability

Simultaneously


CUSTOMER

LIFETIME VALUE


Value

Product

Returns

Future of

Customer

Management

Cross - Buy


Optimal

Allocation of

ResourcesManaging

Multi-channel

Shoppers

Interaction

Orientation


How To Optimize Resource Allocation And Maximize CLV?


Optimal Resource Allocation

How many contacts to be

made to which

customer/distributor and

through what channel?

Increase in ROI due to

decrease in Marketing cost

56



Designing the Optimal Marketing Spend Across Channels

Comprises of the following 3 models:

57

Inter-purchase time modelAt what time intervals is a customer likely to spend?

Customer/Distributor Cash Flow ModelWhat is the future pattern of the cash flows for each customer/distributor,

based on the purchases likely to be made and the marketing costs likely to be incurred ?

Optimal Resource Allocation ModelHow do we apportion limited marketing resources across all the customers/distributors?


What are the Drivers?

Inter-purchase Time Model

• Customer Characteristics

– Switching Costs

– Involvement

– Past Behavior

• Supplier specific Factors

– Level of rich modes

– Level of standardized modes

– Inter-contact time

Cash Flow Model

• Customer Characteristics

– Lagged Contribution Margin

– Establishment Size

– Industry Category

– Total Quantity of Purchases

• Supplier specific Factors

– Total Marketing Communication

58


Optimal Resource Allocation

59

• CLV provides decision support system for allocating the ‗right‘ level of

resources to the ‗right‘ customer so as to maximize profits.

• Example: For a customer exhibiting low share of wallet and low lifetime

value, the resources deployed across various communication channels

would be modified as:– Reduce spending limit to $433 (from $819)

– Decrease frequency of face to face meetings to once every 12.5 months (from 4.5 months)

– Decrease frequency of direct marketing to once every 12.6 days (from 9.7 days)

This will lead to a substantial increase in profits to $12030 from $7435

per customer exhibiting similar characteristics


Database and Analysis Variables

60

Database

B2B high technology customer database

Customer Purchase History

Purchase Timing

Marketing Strategy variables

Premium Service Level

Number of contacts in,

– Face-to-Face Channel

– TeleSales channel

– Direct Mail Channel

– TeleWeb Channel

Number of customer initiated contacts

Customer size and sales

Cross-Buying

Number of Returns

• Analysis Sample

Cohort of Customers who made their first purchase in the first quarter of 1997

Effective Sample Size: N=216


Process Algorithm-Overall Analysis

61

PHASE III

PHASE II

PHASE I

Develop a customer

spending model based on

past revenues and

firmographics

Explain variation in

activity using buyer and

seller time varying

covariates

Inter-purchase time model

Predict the activity status for the next business

cycle using a generalized gamma model and

computing expected time until next purchase

Customer Cash Flow model

Compute Net Present Value of Future Profits

based on predictions from expected cash flows

Implement Optimal Strategy

Optimal Resource Allocation model

Generate optimal cost allocation rules based on

the profit function using Genetic Algorithms

Customer ProfileCustomer Purchase

History

Customer Contact

History


Bought in

the next 12

months

Did not Buy in

the next 12

months

Total

Expected to buy

in next 12 months85% 15 % n=128 (100%)

Not expected to

buy in the next 12

months

12 % 87 % n= 88 (100%)

Results from Phase I -Hit Rate of the Inter-purchase time model


Results from phase II -The Customer Cash Flow Model

Mean Standard

Deviation

Minimum Maximum

Observed 50,199 23,850 -171 1,810,881

Predicted 57,729 24,538 -178 1,897,257

a All reported values are in $ and are rounded off to the nearest integer

Comparison of descriptive statistics between observed cash flow and

Predicted cash flow in the holdout samplea


Combining Phase II and Marketing Costs

• Phase II provides the revenue generated for each individual

customer

• Combining this with the marketing costs provides the profit

computation

• The Profits thus computed are rank ordered by Deciles

• A lift of 7 times is obtained for the first Decile

64


Profit Function

65

1 2 3 4 5 6 7 8 9 10

Decile

0

100

200

300

400

500

(in

th

ou

sa

nd

s)

Ave

rag

e N

et P

rese

nt V

alu

e o

f P

rofit

s

Mean Profit = $55,229


Improvement Over the Currently usedShare of Wallet Approach

66

• Share of Wallet is defined as the ratio of the total customer spending with the firm to the

total category spending(the firm plus its competitors) for that customer. Share of Wallet can

be considered a measure of loyalty

• The Share of Wallet approach yields the following classification of customers and their

average profits

• However a cross analysis of Share of Wallet and Customer Value indicates that a superior

approach can be adopted by identifying more responsive and profitable customers who may

have escaped attention when only the Share of Wallet approach is followed

$19,490

(n=113)

$94,437

(n= 103)

Share of Wallet

Low High

Average Profit


Customer Value versus Share of Wallet: Distribution of Customers

67

Low SOW High SOW

High Value

Cell II – BUTTERFLIES

Avg Profit = $ 35,317 (N= 61)

Cell IV - TRUE FRIENDS

Avg Profit = $ 201,695 (N= 48)

Low Value

Cell I - STRANGERS

Average Profit = $ 925 (N= 52 )

Cell III - BARNACLES

Average Profit = $ 830 (N= 55 )

Customer

Value

Share of WalletThe improved method results

in the following matrix

•Customers are assigned to the low share of wallet segment if their score for share of wallet is less than 0.5.

•The rest of the customers are assigned to the high share of wallet segment.

•Customer Value is calculated using the NPV function.

•Customers are assigned to the low lifetime value segment if their net present value of expected profits

is less than the median value of expected profits from all the customers in the sample.

•The median expected profits in our sample is $1,156.00.


Extent of the Improvement

• We note that the improved method allows us to identify customers

who have a low share of wallet with the firm, but provide high value

(with an average profit of $35,317 versus an average profit of

$19,490 when only share of wallet is used to target customers)

• These customers would have been totally ignored if the uni-

dimensional approach based on share of wallet had been followed

68


Actionable Strategy

69

Customer Value

High

Low

IVII

IIII

Low HighShare of Wallet

Hence this approach is able to identify customers in the low share of wallet

segment who merit marketing investments due to their higher profitability

Marketing action should aim to move customers from Cell III to Cell IV

and from Cell II to Cell IV as a means to improve ongoing profitability.

Cost minimization strategy should be employed to transact with customers

in Cell I

STRANGERS BARNACLES

BUTTERFLIESTRUE FRIENDS


Average Number of Touches/Establishment(B to B Firm)

70

FO

CU

S

PR

IMA

RY

AC

TIV

AT

ION

AC

QU

ISIT

ION

HIG

H

EM

ER

GIN

G

CO

MP

ET

ITIV

E

0

50

100

150

Avg

. T

ou

ch

es

1H03 ACTUAL RECOMMENDEDF

OC

US

PR

IMA

RY

AC

TIV

AT

ION

AC

QU

ISIT

ION

EM

ER

GIN

G

CO

MP

ET

ITIV

E

0

10

20

30

40

50

60

70

Avg T

ouches

Extend reach by moving touches away from Focus and Primary, and toward Activation and Acquisition

Average touch based on total touches to establishments receiving at least 1 proactive touch

Excludes very small business (1-99 enterprise employee size)


Optimal Resource Allocation Matrix

71

Cost Reduction($):

Currently Spending $960

Optimal Spending Limit $2220

Face to Face Meetings:

Currently meets once every 6.6 months

Optimal meeting interval is 2.2 months

Direct Mail/Telesales:

Current Interval is 4.82 days

Optimal Interval is 1.9 days

Profits:

Current Profit is $109,364

Optimal profit is $178,092

Cost Reduction($):









Profits:



Cost Reduction($):









Profits:

Current Profit is $7435


Cost Reduction($):





Optimal meeting interval is 10 months




Profits:



High

Low

Low

HighShare of Wallet

Customer

Lifetime

Value


Managerial Applications of the Framework

• The proposed algorithm enables the firm to take specific marketing actions

for a larger set of customers in the customer list, for a given budget

• The firm can use the framework to assess the return on its marketing

investments and hence bring accountability to marketing actions

• The algorithm is used to provide early indications to the firm about a

customer‘s transition through various phases in his/her life-cycle

(exploration, evaluation, maturity, and decline)

72


Harrah‟s

73

“Technology that helps

Harrah’s keep track of

customer spending and

behavior will continue

to be key to Harrah’s

growth … This thing is the

heart and soul of

Harrah’s.”

Gary Loveman, CEO

Harrah’sSource: ―New Harrah‘s CEO plans Growth Strategy,‖ Peter Henderson, Reuters Update, January 9, 2003


Harrah‟s Business Strategy

74

Established a Brand Identity Based on….

Knowing their

customers wellRewarding customer

loyalty

Giving customers

great service

Source: Academic Case Study. ―Harrah‘s High Payoff from Customer Information, Hugh J. Watson and Linda Volonino 11/01


How well do they know their customers?

75

“Harrah’s has 19 million loyalty

club members worldwide,

and it can identify an individual

by name, spending

habits, and interactions with the

casino-hotel’s restaurants,

web site, stores and

entertainment facilities.”

Source: ―Upping the Profit Ante,‖ Reid A. Paul, HT Magazine, April 2001.


It‟s in the cards!

76

Minimum annual

value of cardholder tier

Diamond: $5,000

Platinum: $ 1,500

Gold: 0

Examples of card-holder data

collected• Basic information such as age, sex, home

address

• Betting patterns; casino-game preferences;

length of play

• Frequency of visits

Growth of Harrah’s customer databaseMillions of customers

1995 1996 1997 1998 1999 2000 2001 2002

5.3

9.9

11.9

13.8

19.0

23.025.0

26.6

Share of Harrah’s 2001 cardholder revenue

by change in cardholders average value’

from 2000 to 2001,percent

40

20

14

16 10

Increased

Value > 3x

Increased

Value < 1x

Increased

Value 1-2x

Did not change or

Decreased value

Increased Value

2-3x


BCP Telecommunicacoes

77

Leading wireless service provider operating

in two regions of Brazil;

1.9 million subscribers @ $700 million / Yr Rev

How BCP Uses DW and Customer Analytics:

• Segmenting customers for more effective campaigns

•Understanding each campaign’s effectiveness

• Knowing and acting on behavioral differences and

preferences across customer base

• Reducing acquisition costs by channel

• Ensuring relevant and timely communications

to each customer

• Knowing what offers a customer will most prefer

• Predicting & pro-actively intervening to prevent churn


LTV Calculation in Class

78


Let‟s go back to the question:

Let‘s look at this exercise!!

79

Dollar value of

the first

purchase

Customer

Lifetime Value


Assignment 5: Lifetime Value of Customers

• Mail order catalog firm

80

Total Customers

7953

Initial purchase<$50

4657

5 years observations

5 years observationsInitial purchase>=$50

3296

Manager: Should I mail catalog to all customers?


Lifetime Value of Customers (Contd.)

81

LTV Pt (Qt t )

d tt 0

n

(Dt Rt )

d tt1

n

A

Pt = the probability of purchase in period t

Qt = the quantity purchased in period t

= the margin on purchases in period t

dt = the discount rate , where d= ( 1+ ( interest rate x risk factor))

Dt = costs to develop the relationship in period t

Rt = cost to retain the customer in period t

A = initial acquisition cost

n = the number of periods

tInclude initial

purchase and

acquisition cost


Decomposition of the Computation

82

LTV Pt (Qt t )

d tt 0

n

(Dt Rt )

d tt1

n

A

•New Customer Acquisition costs

•Average cost to obtain prospect name = $0.10

•Average cost to send initial catalog = $0.75

•Average response rate = 2.3 %

•Number of catalogs

mailed annually to each

acquired customer = 5

•Cost of mailing a catalog

to a customer = $0.75

Tables 1,2,3

Average Margin

on orders =42%

•5. Annual interest rate = 20%

•6. Risk Factor = 1

•d= ( 1+ ( interest rate x risk factor))

Past data: Prob.=1


Lifetime Value of Customers -IllustrationTable 1: <$50 Initial

Purchase Cohort

# Orders 5

0 3837

1 626

2 141

3 38

4 10

5 3

6

7

8 2

9

10

11

12

13

Table 3: Initial and Repeat Order $ Amounts by Year and Group

$ amount of $ amount of

Group initial order repeat order-

Year 5

Initial order N 4657.00 820.00

<$50 Minimum -35.00 4.38

Maximum 50.00 484.91

Mean 31.84 53.63

Std. deviation 9.97 39.31

× =0

=626

=282

=114

=40

=15

=0

=0

=16

=0

=0

=0

=0

=0

×

# of

orders ××1093 $ / order53.63 42% = 24,619,39________

(1+0.2)5 =9,887.31

t

ttt

d

QP )( for t=5

________

4657=2.12


Lifetime Value of Customers –Illustration (Contd.)

5

1

)(

tt

tt

d

RD11.2148

)2.01(

)75.0*5(5

1

t

t A 36.956524657*%3.2

)75.01.0(*4657

Initial purchase<$50

46571 2 3 4 5

A

Pt (Qt t )

d tt 0

5

(Dt Rt )

d tt1

5

LTV


Lifetime Value of Customers (Contd.)

85

LTV Pt (Qt t )

d tt1

n

(Dt Rt )

d tt1

n

Pt = the probability of purchase in period t

Qt = the quantity purchased in period t

= the margin on purchases in period t

dt = the discount rate , where d= ( 1+ ( interest rate x risk factor))

Dt = costs to develop the relationship in period t

Rt = cost to retain the customer in period t

A = initial acquisition cost

n = the number of periods

t Does not include

initial purchase and

acquisition cost


Questions

• What is the average lifetime value of a customer in each of the two groups

(Group1- # of Customers with initial purchase < $50, Group2- # of

Customers with initial purchase >=$50 )? Please calculate for case 1:

including initial purchase and acquisition cost; and case 2: excluding initial

purchase and acquisition cost. Which do you think is the right number for

CLV? Is there a difference in your conclusion?

• Is the decision to mail all catalogs to all customers justified in the light of the

above analysis?

• What other methods of grouping these customers can be considered that

will help us differentiate customers based on their value?

• What can we predict in terms of behavior in the coming year? What

additional analysis would we need?

86


Case Assignment 1: Exotic Apparel

Background:

– Exotic Apparel: Successful retail chain selling high-end women‘s wear and

premium foot wear.

– Revenue: $152 million in 2003; five –year annual revenue growth rate: 6.5%

Question of the Managing director:

87

Past Purchase BehaviorFuture profitability of a

customer



88

Research Areas:

• Determine the Customer Lifetime Value (CLV) of each customer.

• Analyze the profiles of customers segmented based on CLV.

• Determine the profitability of each store.

• Define and measure the extent of loyalty for each customer based on traditional

metrics (Regularity of purchase, Frequency of purchase, RFM score and Tenure of

the customer).

• Determine if customers selected on the basis of traditional metrics are the right

choice from the view of long-term profitability. Check to see if CLV is a better

indicator of long-term profitability than the traditional metrics.

• Determine what factors drive profitability and compare them with the factors that drive

loyalty.



89

Request Data

Calculate Metrics

• Frequency of purchases made by every customer based on each customer’s purchase history.

• Total revenue contributed by each customer through each channel of purchase until the current date.

• Revenue contributed by each customer by product category.

• Average dollar spent per transaction by each customer.。。。。

• Unique number that identified a customer in the database across all the transaction that he/she makes.

• Demographics describing each customer (Age, gender, occupation, income, marital status, number of children, location, distance of residence from a retail store, etc.)

• The shopping behavior exhibited by customers 。。。。

•Lifetime revenue accrued from web sales and factory outlets

•Tenure of the customer

•Dollars spent on high end women’s apparel

•Degree of cross buying

•Dollars spent on Home Furnishings

•Returns made during the lifetime。。。。。。

•Target high spenders in web sales and factory outlets

•Deploy marketing tactics to encourage cross-buying

•Identify customers exhibiting high incidence of net returns and devise strategies to discourage that

behavior

•Encourage customers who spend in high end women‘s apparel

•Target customers exhibiting high duration.

Research

Team

Identify Drivers of CLV



90

Questions:

• By focusing only on profitable customers based on CLV, is the company doing

the right thing from a long-term business point of view? What are the other

decisions that the company can take based on CLV?

• Comment on the strategy recommended by the research team. Are there any

strategies that you would add or remove from this list?

• How different would the recommended strategy be if traditional loyalty metrics

were used instead of CLV?

• It seems intuitive that the first five variables listed have a positive correlation

with CLV. Why do you think that the amount of product returns has an inverted

U-shaped relationship with CLV?


Case Assignment 1: Exotic Apparel (Contd.)

How to Answer?

• This assignment is a comprehensive project that covers the materials

taught in the whole course. After each class, it is suggested to go

back to this case to see how the new concepts and methods can be

applied to solve the questions in this case study.

– Example, RFM will be covered on Day 2 and CLV concept will be

covered on Day 3, and CLV-based management on Day 3 and Day

4, etc.

• The questions require the students to understand the metrics that the

“research team” used to solve the problem, and how they get the

strategic recommendations from those metrics. Most questions

should be answered in essay format, but try to make your point as

clear as possible.

91

Assignment 1-Exotic Case_GSU May Term.docx

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