1. University of Washington EMBA Program Regional 20
5/31/2019
University of Washington EMBA Program Regional 20
“Lifetime Value Analysis”
T.A.: Rory McLeod
5/31/2019

2. Lifetime Value of a Customer
The net present value (less the cost of customer acquisition) that you will receive from transactions with a given customer during the time that you expect this customer to continue to buy from you.
Can help you make marketing strategy decisions:
If an investment increases lifetime value, do it!
If an investment decreases lifetime value, don’t!
Often the benefits of a marketing investment do not come in the first year. This does not make it a bad investment!
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3. Lifetime Value of a Customer
Sophisticated corporations today look further than NPV when trying to assess a customer or customer segments’ Lifetime Value.
In fact, a substantial portion of the customer’s “true” value to the organization can stem from referrals, network effects, and reduced service costs that are not part of “ basic” LTV calculations.
Through the use of relational databases, marketers can append to an individual’s file the value of profit from referrals. This therefore gives a truer picture of the value of a customer and gives permission to spend accordingly to protect this asset.
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4. Ways to Increase Lifetime Value
Increase the retention rate
Increase the referral rate
Increase the spending rate
Decrease the direct costs
Decrease the marketing costs
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5. What is the proper computation period?
Which is the correct lifetime value?
1, 2, 3, 4, 5 or more years?
They are all correct. Which you use depends on your product or service.
Long lifetimes: banks, insurance, utilities, automobiles
Short lifetimes: discount houses, package goods, catalogers
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6. Example: Mary Anne’s Closet
Mary Anne’s Closet is a small chain of stores offering children’s clothing to 100,000 customers. They decide to track 10,000 customers.
The following information is provided:
Retention Rate = 30%
Average customer spends $120 / year
Cost of goods sold (COGS) is 70% of revenue
Current market rate of interest is 8%. They decide to double this number to 16% to account for risk.
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7. Table 10-1. Mary Anne’s Closet
Revenue
Year 1
Year 2
Year 3
R1. Customers
10,000
R2. Retention Rate
30.00%
R3. Spending Rate
$120
R4. Total Revenue
Variable Costs
C1. Percent
70.00%
C2. Total Variable Costs
Profits
P1. Gross Profit
P2. Discount Rate
P3. NPV Profit
P4. Cumulative NPV Profit
L1. Customer Lifetime Value
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8. The Discount Rate
A dollar today is worth more than a dollar in the future.
To convert future profits into today’s money, a discount rate is used.
The discount rate is based on the market rate of interest, plus risk.
D = (1 + i)n, where
i = interest rate (inc. risk)
n = number of years (or periods)
To find the present value of a profit, simply divide that profit by the discount rate.
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9. Table 10-1. Mary Anne’s Closet
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Table Mary Anne’s Closet
Revenue
Year 1
Year 2
Year 3
R1. Customers
10,000
R2. Retention Rate
30.00%
R3. Spending Rate
$120
R4. Total Revenue
Variable Costs
C1. Percent
70.00%
C2. Total Variable Costs
Profits
P1. Gross Profit
P2. Discount Rate
1.00
1.16
1.35
P3. NPV Profit
P4. Cumulative NPV Profit
L1. Customer Lifetime Value
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10. Table 10-1. Mary Anne’s Closet
Revenue
Year 1
Year 2
Year 3
R1. Customers
10,000
3,000
900 (3)
R2. Retention Rate
30.00%
R3. Spending Rate
$120
R4. Total Revenue
$1,200,000
$360,000
$108,000 (4)
Variable Costs
C1. Percent
70.00%
C2. Total Variable Costs
$840,000
$252,000
$75,600 (5)
Profits
P1. Gross Profit
$108,000
$32,400 (6)
P2. Discount Rate
1.00
1.16
1.35
P3. NPV Profit
$93,103
$24,000 (7)
P4. Cumulative NPV Profit
$453,103 (1)
$477,103 (8)
L1. Customer Lifetime Value
$36.00
$45.31 (2)
$47.71 (9)
1. $360,000
+ $93,103
2. (1) / 10,000
3. 3,000 * .3
4. $120 * (3)
* (4)
6. (4) – (5)
7. (6) / 1.35
8. (1) + (7)
9. (8) / 10,000
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11. Mary Anne’s Closet’s Birthday Club
Mary Anne’s Closet has decided to try to increase customer lifetime value by starting a birthday club, which will include:
A 20% discount coupon for any card-carrying-customer buying a present for a child with a birthday that month
“Happy Birthday” balloons as a gift for any birthday child that comes into the store
A small gift to reward referrals
Following are revised assumptions:
Retention Rate = 50%
Referral Rate = 8%
Average customer spending rate = $150 / year
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12. Assumptions: Table 10-2. Mary Anne’s Closet with the Birthday Club
Revenue
Year 1
Year 2
Year 3
R1. Referral Rate 8%
R2. Referred Customers
0 (1)
(5)
R3. Retained Customers
10,000
R4. Total Customers
(6)
R5. Retention Rate
50%
R6. Spending Rate
$150
R7. Total Revenue
Variable Costs
C1. Direct Percent
70%
C2. Direct Costs
C3. Birthday Club Mailing & Gift
(2)
C4. Birthday $4
(3)
C5. Referral $5
(4)
C6. Total Costs
Profits
P1. Gross Profit
P2. Discount Rate
1.00
1.16
1.35
P3. NPV Profit
P4. Cumulative NPV Profit
L1. Customer Lifetime Value
Assumptions:
1. Assume referrals buy in Year 2.
2. $5 per customer: mailing &
balloons.
3. Average of $4 discount per
customer
4. No referrals in Year 1.
5. Referral rate of 8 percent times
Year 1 total customers.
6. Retained customers plus
referred customers.
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13. Assumptions: Table 10-2. Mary Anne’s Closet with the Birthday Club
Revenue
Year 1
Year 2
Year 3
R1. Referral Rate 8%
R2. Referred Customers
0 (1)
800 (5)
464
R3. Retained Customers
10,000
5,000
2,900
R4. Total Customers
5,800 (6)
3,364
R5. Retention Rate
50%
R6. Spending Rate
$150
R7. Total Revenue
$1,500,000
$870,000
$504,600
Variable Costs
C1. Direct Percent
70%
C2. Direct Costs
$1,050,000
$609,000
$353,220
C3. Birthday Club Mailing & Gift
$50,000 (2)
$29,000
$16,820
C4. Birthday $4
$40,000 (3)
$23,200
$13,456
C5. Referral $5
$0 (4)
$4,000
$2,320
C6. Total Costs
$1,140,000
$665,200
$385,816
Profits
P1. Gross Profit
$360,000
$204,800
$118,784
P2. Discount Rate
1.00
1.16
1.35
P3. NPV Profit
$176,552
$87,988
P4. Cumulative NPV Profit
$536,552
$624,540
L1. Customer Lifetime Value
$36.00
$53.66
$62.45
Assumptions:
1. Assume referrals buy in Year 2.
2. $5 per customer: mailing &
balloons.
3. Average of $4 discount per
customer
4. No referrals in Year 1.
5. Referral rate of 8 percent times
Year 1 total customers.
6. Retained customers plus
referred customers.
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14. Net Change in Customer Lifetime Value
(Assume half of the store’s 100,000 customers participate.)
Year 1
Year 2
Year 3
Before the Club
$36.00
$45.31
$47.71
After the Club
$53.66
$62.45
Change
$0.00
$8.35
$14.74
Times 50,000 Customers $0
$417,500
$737,000
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15. 5/31/2019
Thank You!
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