customer lifetime Value

Customer Lifetime Value

Welcome to your Virtual Classroom Recorded Session!

Instructor: Donovan Pfaff / Henrik Simon

SAP AG 2002

Your Instructor

Henrik SimonHenrik SimonHenrik SimonHenrik SimonDepartment of Electronic Commerce

Johann Wolfgang Goethe-University

Donovan PfaffDonovan PfaffDonovan PfaffDonovan PfaffDepartment of Electronic Commerce

Johann Wolfgang Goethe-University

SAP AG 2002

Overview

DefinitionDefinitionDefinitionDefinition

CalculationCalculationCalculationCalculation ModelModelModelModel

SummarySummarySummarySummary

Definition Examples Summary

ExamplesExamplesExamplesExamples

Calculation Model

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„Customer Lifetime Value means the economic value of customer relations during the whole period of relation between customer and company.“

(Source: Krafft (2000) “Kundenbindung und Kundenwert“)

Origin in Direct marketing:

Method of customer segmentation for marketing campaigns

Consequence:

Only these customers should be attended to, whose trade-off of costs and customer retention effect is positive

Long-term oriented method

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Customer Lifetime Value is a longterm and dynamic figure

AverageTurnover

t

Customer 2

Customer 1

Today

Optimum Short-term Strategy

Long-term Strategy

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Overview






Calculation Model

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There are various models to calculate Customer Lifetime Value (CLV)

A few elements are part of all CLV models:Period under consideration of analysis (e.g. month, quarter)

Discount rate of a company (cost of capital)

Planning horizon (how many periods)

Frequency of buying/turnover

Average turnover per buying

Estimated customer retention

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GCi: Amount of coverage per customer iMi: Relevant acquistion and marketing costs per customer iT: Planning horizonr: Customer retention rate d: Discount ratet: Time index

Source: P. Berger/N. Nasr (1998), “Customer Lifetime Value: Marketing Models and Applications”

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Overview






Calculation Model

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Customer Lifetime Value – Example calculation

Year 1 Year 2 Year 3Customers 20.000 12.000 7.800Retention Rate 60% 65% 70%Orders/year 1,8 2,6 3,6Average Order Size $2.980 $5.589 $9.106Total Revenue $107.280.000 $174.376.800 $244.696.480

Direct Cost 70% 65% 63%Costs $75.096.000 $113.344.920 $161.088.782Acquisition Cost $630 $12.600.000 $0 $0Total Costs $87.696.000 $113.344.920 $161.088.782

Gross Profit $19.584.000 $61.031.880 $94.607.698Discount Rate 1,13 1,81 2,53Net Present Value Profit $17.330.973 $33.719.271 $37.394.347Cumulative NPV Profit $17.330.973 $51.050.244 $88.444.591CLV $867 $2.553 $4.422Source: A.M. Hughes (2001), “Using Lifetime Value in Business to Business Marketing”

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ABC Analysis in Comparison with CLV

Number of Customers

Average Annual ($)

Total Sales ($)

Sales Ranking

Lifetime Value ($)

CLV Ranking

Basic User 254 $335.736 $86.202.044 4 $145.067 2Light User 15.442 $13.851 $213.887.142 1 $5.914 4Heavy User 44 $2.314.159 $101.822.996 3 $988.146 1Top User 612 $299.007 $182.992.284 2 $127.676 3Others 3.613 $2.176 $7.861.888 5 $929 5Total 19.965 $29.695 $592.857.254 $12.680

Source: A.M. Hughes (2001), “Using Lifetime Value in Business to Business Marketing”

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CLV is increasingly used as a measurement category of Customer Relationship Management (CRM):

Identification of profitable customer segments

Impact of new channels of distribution (multi channeling) on customer value (“Value driver”)

Aggregated CLV as “Customer Equity”

Drawing on customer equity as indicator for the enterprise value

Carrying out marketing campaign management (CRM) according to customer values

Aligning pricing and product design with CLV Basis

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Calculation Example RoI

75 %Return on investment (project)

35 Mio.Improvement of aggregated customer values (segment )

2,68 %Improvement of customer lifetime value

0.5Improvement of customersatisfaction, customer retention

20 Mio.Costs per project

Source: R. Rust / V. Zeithaml / K. Lemon (2000), “Driving Customer Equity”

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Research Approaches (Selection)

Customer Lifetime Value in support of marketing decisions (CRM)

i.e. Dwyer, F.R. (1989), “Customer Lifetime Valuation to SupportMarketing Decision Making”also P. E. Pfeifer, J. Cornelsen, H. Diller

Customer retention, pricing and product design on CLV basisi.e. Krafft, M. (2000), “Kundenbindung und Kundenwert”

Aggregated CLV: Customer Equity

Impact of CLV on shareholder valuei.e. Rust, R.T. / Lemon, K. N. / Zeithaml, V. A. (2000), “Driving Customer Equity”

i.e. Berger, P.D. / Nasr, N.L. (1998), “Customer Lifetime Value: Marketing Models and Applications”

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Overview






Calculation Model

SAP AG 2002

Summary

Customer Lifetime Value means the economic value of customerrelations during the whole period of relation between customer and company.

Therefore the Customer Lifetime Value is a very important business performance figure.

As it allows to measure the value of a customer of a company in monetary meanings for the first time, Customer Lifetime Value is of increasing importancein various industries.

Only a few financial figures are needed to work out the CLV of a customer (i.e. margin, planning horizon, discount rate, etc.).

Equivalent to the brand equity of a firm you can easily work out its customer equity by aggregating all CLV.

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