pop

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 2: Customer Loyalty, Profitability, and CLV

drvkumar.com© Dr. V Kumar

Loyalty and Profitability

2


Evolution of Loyalty Programs

3

Airlines

Hotels

Early 80’s

RetailEarly 90’s

Mid 90’s

Late 90’s

Mid 80’s

Credit Card

21st

Century

Financial Services

VIRTUALLY

EVERY

INDUSTRY!!!


Airline Loyalty Programs-How Do They Work?


Frequent Flyer Programs

Airline Frequent Flyer Program


What Should the Programs Reward?

Loyalty…..of course!


What Are The Major Airlines using to Compute Mileage Points?

Airline Miles flown Number of

round trips

made

American

Airlines

√ -

United √ -

Continental √ -

Delta √ -

US Airways √ -

Southwest - √


Southwest – Rapid Rewards - Back to the Future

• Earning Rewards

– 1 free award ticket for every 8 roundtrips (16 credits) (or 4 roundtrips

purchased online) in 12 consecutive months

– Companion Pass for 1 year- After 100 credits

– Can use only preceding 12 months for credit (each credit is valid for 12

months only, after which it expires if unused)


Net Income Over The Years

-600

-400

-200

0

200

400

600

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

$ (M

illio

ns

)

Year

Continental Airlines


Net Income Over The Years (Contd.)

0

200

400

600

8001

99

5

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

$ (M

illio

ns)

Year

Southwest Airlines


Key Implications

• Airline performances in recent years have been affected by a

variety of reasons

• Indiscriminate frequent flyer miles is but one of the factors

• Standing out from the crowd also pays dividends (Southwest)


Examples of Loyalty Programs in India-Jet Privilege

• Dynamic tier review (12-month, 18-month, 24-month)

• Fast-track upgrade

• SMS updates

• Earn miles on code-share carriers

• Redeem miles with tickets/gifts/partners

• Purchase miles in case of shortfall

13


Jet Airways - Jet Privilege

• ―Freddie‖ awards from 2004 to 2007 and APAC

―Program of the Year‖ in 2006 and 2007

• Information easily available on the Web

• Easy enrollment: Online/in-person counters

• Book and pay by Web, IVR, mobile

• Tele, Web, kiosk, SMS check-in

• Online tools for miles, status, and upgrade calculations

• 44 destinations to earn/redeem miles from/to

14


• Activities◦ Build a Sun community on campus

◦ Share knowledge about latest Sun on campus

◦ Activities such as starting a Sun user-group, demonstrating Sun technology to fellow students, promoting Sun events and contests, and blogging

◦ 105 strong over 3 years in India

◦ Rewards◦ Free training

◦ Discounts on Sun certification exams

◦ Access to the latest technology

◦ Promotion to Student Tech Lead

◦ INR 6.5k p.m.

Examples of Loyalty Programs in India-Sun Campus Ambassador Program

15


87%85%

50% 45% 35%

Insurance Publishing Credit

Card

Industrial

DistributionSoftware

Frederick Reichheld‘s The Loyalty demonstrated

that a small improvement in customer retention can

have a disproportionately large effect on customer

lifetime value

Impact of a Five Percent Increase in

Retention on Customer NPV


Loyalty - At What Cost?


Loyalty - - At What Cost?

• Welf Ebeling, chief operating officer for The Leading Hotels of the World group,

ran the Breidenbacher Hof, a swanky hotel in Düsseldorf.

• One fine day he noticed that some of his most loyal customers constantly

telephoned the concierge with impossible requests.

• These ―attention-seekers‖ were often less profitable than other loyal customers

who made fewer demands but spent more.

• Companies tend to assume that loyal customers are cheaper to serve and

willing to pay more than others, and also good at attracting new business

• Let us discuss the case studies of a high-tech corporate-services provider, a

French grocery group, a German broking house and an American mail-order

company and try to find the correlation between loyalty and profitability


Loyalty - - At What Cost? (Contd.)

• Across the 4 different industry categories

– Employ cross-sectional, longitudinal profitability

tracking for customer cohorts

– Ensure that complete purchase and service

behavior is tracked on the individual account level

over time


Examining The Myths Surrounding Loyalty

Myth # 1:

The costs of serving loyal customers are lower

Myth # 2:

Loyal customers pay higher prices for the same bundle of goods

Myth # 3:

Loyal customers engage in more positive word-of-mouth

Myth # 4:

Relationships with loyal customers are more profitable


Myth # 1: The Costs Of Serving Loyal Customers Are Lower

• Empirical results for all four industries indicate

– a greater heterogeneity across customers in costs to serve

– a very weak linkage of costs to serve and the duration of a

customer relationship

Assuming that interaction cost decreases over time when in fact it

doesn’t, gives a false sense of loyalty benefits


Myth # 2: Loyal Customers Pay Higher Prices For The Same Bundle Of Goods

• Examined the case of a leading grocery retailer in France to

measure consumer‘s attitudinal and behavioral loyalty towards the

supermarket

• The high attitudinal and high behavioral loyalty cell was termed the

top loyalty group and the low attitudinal and the low behavioral

loyalty cell was termed the bottom loyalty group

• Analyzed the average price these customers paid for products in

various grocery categories across all four cells


Comparison Of The Average Price Paid Across Groups

0

0.5

1

1.5

2

2.5

3

3.5

4

Beverages Household

Cleaning

Epic.

Sucree

Epic. Salee Fresh

Products

Dairy

Avg. price

in € Top loyalty quartile

Bottom loyalty quartile

Differences are not statistically significant


Loyal Customers Pay Higher Prices For The Same Bundle Of Goods- Across Other Industry Categories (Contd.)

• General merchandise catalog retailer -The average price paid for a

SKU was highest for non-loyal customers, who paid approximately

9% higher prices than the loyal customers in the same product

category

• High-tech firm -On the average, the loyal customers paid about 5%

to 7% lower than the non-loyal customers depending on the product

category

• Therefore, we find no empirical evidence for the assumption that

loyals are less price-sensitive


Theoretical Arguments In Favor Of Our Empirical Findings

• Loyal customers are more likely to learn about product offerings,

compare quality standards and develop solid reference prices

• Competitive pressure amongst vendors not to price discriminate

on the basis of customer loyalty, due to the fear of loosing a very

important segment

• Price of products and services in most B-to-C markets is fixed

• The notion of charging de facto higher prices to loyal customers

goes against a natural human desire for fair treatment


Myth # 3: Loyal CustomersEngage In More Positive Word-of-mouth

French grocery retailer –

2.77

4.46

3.05

4.25

0

1

2

3

4

5

Low HighAttitudinal Loyalty

Rati

ng

(1

-5)

Low Behavioral Loyalty

High Behavioral Loyalty

Engagement in active Word-of-mouth

Customers are not engaging in spreading positive word-of-mouth about the company based on how often or how much they buy (i.e. behavioral loyalty). It is the attitudinal loyalty that counts


Loyal Customers Engage In More Positive Word-of-mouth Across Other Industry Categories

• Similar results were observed in the case of the high

tech firm

– Among the customers with higher attitudinal loyalty, the

intention to recommend was greater for the high behavioral

loyalty group than the low behavioral loyalty group


Loyal Customers Engage In More Positive Word-of-Mouth Across Other Industry Categories (Contd.)

• For the customers with lower attitudinal loyalty, there

was no difference in the intention to recommend

between the high and low behavioral loyalty group

• Thus in terms of word-of-mouth management it does

not matter how often customers buy but what matters

is what they think about you!


Myth # 4: Relationships With Loyal Customers Are More Profitable

• This hypothesis presumes that bottom-line results are better

for loyal customers

• Unless the relationship between profits and customer loyalty is

measured, there is no way to know for sure

Therefore it is important to know “How strong is this correlation?”


Lifetime Duration – Profitability Association

Short LongLifetime

Duration

High

Low

Lifetime

Profit

Conceptual Model

In reality, is this relationship observed?

IV

III II

I


Association between Profitability and Longevity of Customers

Source: “The mismanagement of customer loyalty”, Werner Reinartz, V Kumar. Harvard Business

Review


Correlation Measure Across Industries

Industry Correlation Sample Size

B-to-B high tech 0.28-0.31 4128

Grocery retail 0.45 250

General merchandise

direct mail

0.17-0.22 9105

Direct brokerage 0.29 3014

In reality we observe low correlations across all industry categories


The Reality!

• The link between loyalty and profitability is weaker than ordinarily

assumed

• Not all loyal customers are worth a resource intensive interaction

• Short-life customers are not always bad

• Low share of wallet customers are also not bad


What Happens If The Loyalty-profitability Space Is Badly Understood ?

-2000.00

0.00

2000.00

4000.00

6000.00

8000.00

10000.00

12000.00

14000.00

16000.00

18000.00

20000.00

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

Month

($) S

egm

ent P

rofit

Short life, low

revenue

(Segment 4)

Short life, high

revenue

(Segment 3)

The firm incurs losses on two short-life segments after about 20 months into

the relationship. This is a result of over investing due to backward-looking

customer scoring.

A study of a general

merchandise catalog retailer

in the US

Segment Profits ($) for Two Short-life Segments


-2000.00

0.00

2000.00

4000.00

6000.00

8000.00

10000.00

12000.00

14000.00

16000.00

18000.00

20000.00

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

Se

gm

en

t P

rofi

t ($

)

Month

Aggregate Profits (Dollars) for Long-Life Segments

Long life, low

revenue

(Segment 2)

Long Life, high

revenue

(Segment 1)

What Happens If The Loyalty-profitability SpaceIs Badly Understood ? (Contd.)

Segment Profits ($) for Two Long-life Segments


What happens if the Loyalty-Profitability space is badly understood ?

36

0

5000

10000

15000

20000

25000

Cu

sto

me

r P

rofit ($

)

Month

Customer 1

(Segment II)

Customer 2

(Segment III)

Today


What Drives Profitable Customer Loyalty?

Exchange Characteristics

– Customer‘s spending level - Share of

Wallet

– Cross-buying behavior

– Focused buying behavior

– Average Interpurchase Time

– Merchandise returned

– Ownership of loyalty instrument

– Mailing efforts of the company

– Majority Product category

37

Customer Heterogeneity

–Age

–Spatial Location

–Income


Understanding The Drivers Of Customer Loyalty: Relationship Characteristics That Impact Profitable Lifetime Duration

• We now identify factors under a manager‘s control that explain the variation in the profitable lifetime duration

• The focus of our inquiry is on variables that determine the nature of the customer-firm exchange

• Exchange characteristics encompass the set of variables that define and describe relationship activities in the broadest sense

• The profitable duration of a customer-firm relationship depends, differentially, on the exchange characteristics at time t, and customer heterogeneity

Profitable Lifetime Durationi = f (Exchange characteristicsit, Customerheterogeneityi)


Analysis

• We used Survival analysis for the analysis of profitable

customer lifetime durations

• It is the method of choice in dealing with duration data, in particular because it

is well suited for the handling of censoring

• The hazard rate is defined as the probability of buying, given that a customer

has not bought until now

• The hazard of a lifetime event of a household i at time t is given as follows:

hi(t) = h0(t) EXP (β1 Purchase Amountit + β2 Cross Buyingit + β3 Focus of Buyingi

+β4 Average Interpurchase Timeit + β5 (Average Interpurchase

Timeit)2 + γ1 Returnsit + γ2 Loyalty Instrumenti + γ3 Mailingsit

+ γ4 Product Categoryi + δ1 Population Densityi + δ2 Incomei

+ δ3 Agei)


Building Good Loyalty Programs

40


Key Objectives of Loyalty Programs

• Building true (attitudinal & behavioral) loyalty

• Efficiency Profits

• Effectiveness Profits

• Value alignment

41


Building True Loyalty

• Encompasses both attitudinal and behavioral components of loyalty

• Greater commitment to the product or organization through the

building of true loyalty

• Function of true value provided to the customers

• Involves degree of involvement in the product category, visibility of

the product when using it, or value expressive nature of the product

• Goal of many customer clubs

• Difficult in the case of a low involvement category– e.g.: grocery

shopping

42

Loyalty


Supermarkets - Difficulty in Building True Loyalty

• Despite spending hundreds of millions of pounds on price-cutting

campaigns and loyalty card schemes, supermarkets have only persuaded

a small minority of shoppers to stay loyal

• According to a report from Mintel Research:

– Only 15% of all grocery shoppers are completely loyal to the store where they

do their main grocery shopping

– 29% use one other store

– 22% use two others

– Men are more likely than women to be loyal to a single store

– 46% of men shop in just one or two main stores

43


Marketing

Strategy

Efficiency Effectiveness

Loyalty

Program

Is LP the right thing to do with given

resources? Measured in terms of the immediate profit

consequences (from changing customer‘s

buying behavior via LP) as compared to profit

consequences without LP– net of the LP cost .

How?Change in buying behavior can be

measured, in: •Basket size

•Purchase frequency acceleration

•Price sensitivity

•Share of category requirements (SCR) or

share-of-wallet

•Retention

•Lifetime duration

Is LP correctively implemented? Measured in terms of the profit outcomes of

specific marketing actions In LP (Conversion

rate for a marketing campaign, marketing

communications reach etc).

How?

•Using a LP to have a better learning about

customer preferences over time. significant

gains for both customers and organizations.

•Allows sustainable value creation for

customers through customization of products or

communication

•Customers get more of what they truly want,

and firms are safe in terms of not having to

engage in a costly mass marketing exercise

Sustainable

Competitive

Advantage


Value Alignment

• Goal of aligning the cost to serve a particular

customer with the value he/she brings to the firm

• Allows firms to serve their most valuable customers in the best manner

• The goal of value alignment is particularly critical when there is great

heterogeneity in the customer‘s value and in the cost to serve the

customer

Example: the airline business, the hospitality industry and the financial

services industry

45


Loyalty Program Design Characteristics

• Classified according to:

– Reward structure

– Sponsorship (existence of partner network, network externalities)

• To know if an LP is effective:

– From the consumer‘s perspective, are rewards attainable?

– From the consumer‘s perspective, are rewards relevant?

– From the firm‘s perspective, is the LP design aligned with the

desired goal(s)?

46


Representative examples of Program

Failures and Missteps

SAFEWAY

Industry: Grocery Retail (UK)

Program: ABC Card

Launch: 1995

Program Overview:

• Innovative loyalty scheme (ABC

Card) given to study repeat purchase

• Abandoned since information

generated could not justify the high

costs

• Safeway today focuses on weekly

promotions and improved customer

service

LATIN PASS

Industry: Airline

Program: Latin Pass

Launch: 1994

Program Overview:

• Awarded 1 million frequent flyer miles to customers who visited 10 Latin American countries, utilized hotel and car rental services

• 50 customers qualified in a very short time period

• Abandoned campaign prematurely due to very high customer costs ($10000 per customer)


Case in Point: Drivers of Airline Preference

1 Market Coverage

2 Price

3 Schedule

4 Frequent flyer program

5 Product attributes

48

Airline travelers that cite five main factors that

drive their choice of airlines:

Council airline

members note

that frequent flyer

programs are only

one of the factors

that determine a

customer‘s choice

of airline


What Did The Programs Assume?

• Loyal customers are more profitable

• Hence, for many years, ‗Miles flown‘ was used as the sole

measure of loyalty and was accepted as a surrogate measure of

profitability

• Rewards were redeemed in proportion to the ‗Miles‘ accumulated

on a customer‘s account

49


The Not-So-Obvious Shortcomings

The ‘Miles’ rewards system:

• Did not account for the revenue that a customer brought in

– Class of travel

– Fare type

• Rewarded a more valuable customer the same as a less valuable

customer

• Ignored the willingness by a customer to pay more for a better

product/service

Hence sooner or later, all this had to change

50


Previous Program New Program

Qualification criteria:

Base miles, or flight

segments flown in one

calendar year

Qualification criteria:

Medallion miles earned

based on distance traveled

and fare class purchased in

one calendar year

Delta Airways - Ringing in the changes

•Effective January 2003, the requirements for achieving elite-level status have

changed. You now qualify based on Medallion Qualification Miles—a multiple of

the distance traveled and fare purchased—instead of miles or segments flown, as

in the previous program

•This allows customers willing to pay more for additional benefits to gain status

more quickly


Delta Airlines- Miles Redemption Table

Class of Service Fare Type Medallion Miles

Qualification

Formula:

Using an example of

500 flown miles

Total Medallion

Miles Earned for

Qualification

First, BusinessElite

or business

P, F, A, C, D, J, I 500 x 2 1,000

Economy Y, B, M 500 x 1.5 750

Discounted

coach/economy

H, Q, K, S 500 x 1 500

Deeply-discounted

coach/economy

L, U, T 500 x .5 250

SkyMiles Award/

Special Fares

R, O, N, E 500 x 0 No Medallion

Qualification Miles

earned

52


What Are The Major Airlines Using To Compute Mileage Points Today ?

Airline Miles flown Class of

service(Economy, Business,

1st Class)

Fare Type Number of

round trips

made

American

Airlines

√ √ - -

United √ √ - -

Continental √ √ - -

Delta √ √ √ -

US Airways √ √ - -

Southwest - - - √

53


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

54


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?

55


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

56

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


Total Membership/Program Characteristics by Brand

57

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

58

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

59


Customer Loyalty and CLV

60


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.

62

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.

64


Understanding the different components of CLV

65


Gross Contribution Margin (GC)

66

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

67

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.

68

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:

69


Measuring Customer Lifetime ValueCase I- P&C Insurance Company

70

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

71

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%


Progression in CLV Measurement

• Case I represents CLV

predictions on an average for

all customers

• Current techniques focus on

predicting CLV for each

individual customer in a

dynamic fashion

Individual Customers

Customer Segments

All Customers

72


When is a customer still a customer?

73

Probability (Alive) = tn

where n is the number of purchases in a given period and

t is the time of the last purchase (expressed as a fraction)

Customer 1: t = (8/12) = 0.6667 and n = 4

Thus: Prob. (Alive) = (0.6667)4 = 0.197

Customer 2: t = (8/12) = 0.6667 and n = 2

Thus: Prob. (Alive) = (0.6667)2 = 0.444

Customer 1

Customer 2

x x x

x x

x

Month 1 Month 12 Month 18

Observation period Holdout period

?

Month 8


Issues At Hand

• Based on the probability estimates, Customer 2 seems to be more

promising

• What else do we need to know?

74

Customer 1 Customer 2

Gross Margin $100 $50

Prob (Active) 0.2 0.4

Therefore, Expected Gross Margin =

Gross Margin * Prob (Active)

$20 $20

Now, which customer is more profitable?


Issues At Hand (contd.)

• Consider the marketing communication cost for each of the

customers:

75

Customer 1 Customer 2

Expected Gross Margin $20 $20

Marketing communication cost $10 $15

Therefore, Expected Net Margin =

Expected Gross Margin – Marketing Cost

$10 $5

Thus, Customer 1 is more profitable than Customer 2

after accounting for future customer revenue and cost


Calculation of NPV

76

tT

ditACMt

itAlivePi

GCofNPV

1

1*

1)(

Where

NPV = Net Present Value

GCi = estimated expected gross contribution margin for customer i

ACMit = average monthly gross contribution margin for month t based on all prior purchases

d = discount rate for month t (15% on a yearly basis)

i = customer

t is the month for which NPV is being estimated

T is the number of months ahead that are included in the forecast

P(Alive) is the probability that customer i is alive in month t


24.127$

81.5543.71

)12.1/1(*100*7.0

)12.1/1(*100*8.0

1

1*

1)( of NPV

2

1

2

t

ditACMt

itAlivePi

GCM

Calculation of NPV: An Example

t

ditACMt

itAlivePi

GC

1

1*

1)( ofNPV

2

ACMit = 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.


When To Stop Chasing???

• The important factor in deciding when and which customers to let go of is the measurement of profitable customer lifetime duration

78

• Decision Rule:

– If NPV of Expected contribution margin is less than cost of

mailing, then the firm would decide to terminate the

relationship

• Using the above decision rule, we can establish for every

customer at what point he is subjected to the proposed

termination policy


P(Alive) and NPV Calculation in Class

80

pop

Documents

v kumar7what

v kumar20examining

v kumarrichard

v kumarloyalty

v kumar17loyalty

v kumar8what

v kumar1687

v kumar19loyalty