UCEA Mini-Workshop onDatabase Marketing

Arthur Middleton HughesVice President / Solutions

ArchitectKnowledgeBase Marketing

Hyatt Fisherman’s WharfSan Francisco Feb 14, 2002

What KnowledgeBase Marketing Does

Compared with newcomers, Long term customers: Buy more per year Buy higher priced options Buy more often Are less price sensitive Are less costly to serve Are more loyal Have a higher lifetime value

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Percentage Retained

from Previous

Year

1 2 3 4 5

Years as a customer

Retention is the way to measure loyalty

Retention pays better than acquisition

($62)

$48

($80)($60)($40)($20)

$0$20$40$60

New Customer 3rd YearCustomer

Annual Profit

Manufacturer of building products Catalog sent to 45,000 contractors Previous policy: wait for the orders Test: pick 1,200 customers, split into test

of 600 and control of 600 Two person pilot program build

relationship with test customers to see the results

Credit: Hunter Business Direct

What proves that relationship building works?

What did they offer? Follow up on bids and quotes Schedule product training Make aware of pricing specials Ask about customer needs Product comparison information New Product information They did not offer discounts

73%

76%

72%72%73%73%74%74%75%75%76%76%

Percent who

purchased in 6 months

1 2

Control vs Test Group

Improvement in Response rate

82%

112%

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20%

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60%

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100%

120%

Change in number of

orders

1 2

Control vs Test Groups

Change in the number of orders

86%

114%

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60%

80%

100%

120%

Change in average

order size

1 2

Control vs Test Group

Change in the Average Order Size

70%

127%

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120%

140%

Change in total

revenue

1 2

Control vs Test Group

Total revenue gain: $2.6 million dollars

This stuff works! Building a relationship with

customers can be highly profitable

Using a database to recreate the old family grocer is a winning strategy

Relationship marketing is the way to go

Why we need Lifetime Value Analysis

We need to know the value of our customers, so as to properly target our sales and retention efforts

We need to discriminate among our customers to acquire and retain the best

Lifetime Value Analysis Goal: Determine...

where to put your retention dollars the value of each retention strategy where to put your acquisition dollars how much to spend on acquisition

What is lifetime value?

Net present value of the profit to be realized on the average new customer during a given number of years.

Lifetime value is “Good Will.” To compute it, you must be able to

track customers from year to year. Main use: To evaluate strategy.

Year 1 Year 2 Year 3Retention Rate 40% 45% 50%Students 10,000 4,000 1,800 Courses/Year 2.8 3.0 3.2Cost per course $605 $605 $605Revenue $16,940,000 $7,260,000 $3,484,800

Costs Percent 80% 77% 75%Costs $13,552,000 $5,590,200 $2,613,600Retention Costs $12 $120,000 $48,000 $21,600Total Costs $13,672,000 $5,638,200 $2,635,200

Profit $3,268,000 $1,621,800 $849,600Discount Rate 1.00 1.17 1.36NPV Profit $3,268,000 $1,386,154 $624,706Cumulative NPV $3,268,000 $4,654,154 $5,278,860Lifetime Value $326.80 $465.42 $527.89

Market Rate of Interest...6%Assume Risk 1.2 first year, 1.1 afterwardsYears = n Interest = iFormula: D = (1 + I * risk)n

Calculation of rate after 2 years: D = (1.06 * 1.1)2 = 1.36

Discount Rate Basic Formula

Annual Rate = (Repurchase rate) (1/years)

77% repurchase after 11 years Annual Rate = (.77)(1/11) = 98%45% repurchase after 4 years = 82%99% per week = 59.2% per yearAnnual = (.99) (1/(1/52))

Annual Rate = 59.2%

Convert to Annual

Build a database linked to the website

Web registrationFrequent personal

communicationsWeb site cost $30 per student per

yearCommunications extra cost $18

per student per year

New Retention Strategies

Year 1 Year 2 Year 3Retention Rate 45% 50% 55%Students 10,000 4,500 2,250 Courses/Year 3.0 3.5 4.0Revenue per Course $605 $605 $605Revenue $18,150,000 $9,528,750 $5,445,000

Costs Percent 75% 72% 70%Costs $13,612,500 $6,860,700 $3,811,500Web Costs $30 $300,000 $135,000 $67,500Retention Costs $30 $300,000 $135,000 $67,500Total Costs $14,212,500 $7,130,700 $3,946,500

Profit $3,937,500 $2,398,050 $1,498,500Discount Rate 1.00 1.17 1.36NPV Profit $3,937,500 $2,049,615 $1,101,838Cumulative NPV $3,937,500 $5,987,115 $7,088,954Lifetime Value $393.75 $598.71 $708.90

Effect of adoption of new strategies $1.8 million in the third year Profit, after all expenses paid

Year 1 Year 2 Year 3New LTV $393.75 $598.71 $708.90Old LTV $326.80 $465.42 $527.89Change $66.95 $133.30 $181.01Times 10,000 $669,500 $1,332,962 $1,810,094

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.

Short lifetimes: continuing education.

Increase the retention rate Increase the referral rate Increase the spending rate Decrease the direct costs Decrease the marketing costs

Five Ways to Boost LTV with DB Strategies

How to use lifetime value

Compute a base lifetime value Dream up a new strategy Estimate the benefits and costs Determine whether your new lifetime

value goes up or goes down Don’t undertake any new strategy

until you can prove it will be successful

Find LTV of Customer Segments Many UCEA customers are quite

different in their purchase patterns Create actionable segments and

determine the value of each Use the results to focus your

retention programs and acquisition programs on the most profitable segments

Dividing Customers into Three Segments Develop a different strategy for

each segment

Quantity LTV TotalDegree Candidates 4,000 $1,126 $4,504,000Retirees 2,000 $329 $658,000Job Training 4,000 $482 $1,928,000Total 10,000 $7,090,000

Different marketing strategies Job training: market to companies Degree Candidates: market both to

companies and individuals Senior Citizens: market to

individuals

Using lifetime value to get budget approval

Database marketing budgets are usually carved from somewhere else

You have to prove that you will make better use of the funds than the others

Lifetime value can supply testable numbers that CFO’s can understand

Base your budget on solid numbers backed up by valid tests

What your new budget will buy

Year 1 Year 2 Year 3New LTV $393.75 $598.71 $708.90Old LTV $326.80 $465.42 $527.89Change $66.95 $133.30 $181.01Times 10,000 $669,500 $1,332,962 $1,810,094

Year 1 Year 2 Year 3Retention Rate 45% 50% 55%Students 10,000 4,500 2,250 Courses/Year 3.0 3.5 4.0Revenue per Course $605 $605 $605Revenue $18,150,000 $9,528,750 $5,445,000

Costs Percent 75% 72% 70%Costs $13,612,500 $6,860,700 $3,811,500Web Costs $30 $300,000 $135,000 $67,500Retention Costs $30 $300,000 $135,000 $67,500Total Costs $14,212,500 $7,130,700 $3,946,500

Profit $3,937,500 $2,398,050 $1,498,500Discount Rate 1.00 1.17 1.36NPV Profit $3,937,500 $2,049,615 $1,101,838Cumulative NPV $3,937,500 $5,987,115 $7,088,954Lifetime Value $393.75 $598.71 $708.90

Using lifetime value to get budget approval

Database marketing budgets are usually carved from somewhere else

You have to prove that you will make better use of the funds than the others

Lifetime value can supply testable numbers that CFO’s can understand

Base your budget on solid numbers backed up by valid tests

Recency, Frequency, Monetary Analysis

How to attract and hold relationship buyers

Forget price. Think and talk about quality and service.Build a relationship with the buyerAdd value to product and relationshipFind way for buyer to build equityMake it expensive to switch

How to identify responsive customers

Some customers respond, some don’t How can you predict behavior? Best method: look at past behavior Behavioral indicators:

Recent purchasers Frequent purchasers Large spenders

Responsive customers may not be the most profitable

Profitable Customers

Responsive Customers

Not all responsive customers are profitable

Not all profitable customers will respond when you write them.

LTV RFM

RFM Can Predict Responders Use RFM to select most likely

responders Use combination of mail,

phone, and emails to responsive relationship buyers.

How to Apply Recency Codes

Put most recent purchase date into every customer record

Sort database by that date - newest to oldest Divide into five equal parts - Quintiles Assign “5” to top group, “4” to next, etc. Put quintile number in each customer record

Response by Recency Quintile

3.49%

1.25% 1.08%0.63%

0.26%

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2.50%

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5 4 3 2 1

Recency Quintile

Res

pons

e R

ate

How to compute a Frequency Index Keep number of transactions in

customer record Sort Recency Groups from highest

to lowest Divide into five equal groups Number groups from 5 to 1 Put Quintile number in each

customer record

Response by Frequency Quintile

1.99%

1.56%1.31%

0.92% 0.93%

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2.50%

5 4 3 2 1Frequency Quintile

Re

sp

onse

Ra

te

How to compute a Monetary Index Store total dollars purchased in

each customer record Sort Frequency Groups from highest

to lowest Divide into 5 equal groups

(Quintiles) Number Quintiles 5, 4, 3, 2, 1 Put Quintile number in each record

Response by Monetary Quintile1.61%

1.45% 1.46%

1.22% 1.23%

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0.80%

1.00%

1.20%

1.40%

1.60%

1.80%

5 4 3 2 1

Monetary Response to $5,000 Product

Monetary Quintile

Percentage of households promoted who purchased

1.68

1.170.88

0.66

0.32

5 4 3 2 10

0.5

1

1.5

2

RFM Code Construction

FM

One SortFive Sorts

Twenty-five sorts

Database

5

4

3

2

1

35

34

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31

335334333332331

R

Appended RFM Codes

Customer Database

Nth

Creating an Nth

300,000 Records

30,000 Records

For Nth by 10, select every tenth record.

Result will be statistical replica of database

Result of Test Mailing to 30,000

# RFM Mailed Response Rate1 555 240 20 8.15%2 554 240 16 6.56%3 553 240 13 5.62%4 552 240 10 4.33%5 551 240 11 4.51%

6 545 240 9 3.78%7 544 240 12 4.98%8 543 240 6 2.88%9 542 240 10 4.26%10 541 240 7 3.10%

11 535 240 10 4.13%12 534 240 9 3.83%13 533 240 8 3.35%14 532 240 6 2.70%

Test Response Rate by RFM Cell

-200

-100

0

100

200

300

400

500

555 455 355 255 111

Index of Response 0 = Break Even

Profit from Test Mailing

Quantity Rate Amount

Goods Sold 402 $40.00 $16,080

Mailing Costs 30,000 $0.55 $16,500

Profits (Loss) ($420)

Determine Break Even and Test Sizes

How to Compute the Response Rate Divide number of responses by

number mailed. Multiply by 100 Example: Responses = 1034

Mailed = 40,000Rate = 1034 /

40,000Rate = 2.59%

Test, Full File & RFM Selects Compared

Test Full File RFM SelectResponse Rate 1.34% 1.17% 2.76%Responses 402 23,412 15,295Net Revenue $16,080 $936,480 $611,800No. Mailed 30,000 2,001,056 554,182Mailing Cost $16,500 $1,100,581 $304,800

Profits ($420) ($164,101) $307,000

Test Vs Rollout Response Rates

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554 553 552 551 545 544 543 542 541 535 534 533 532 531 525 524 523 522 521 515 514 513 512 511 455 451 445 444 443 355 354 351 344

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Retroactive RFM Test

Many times there is not enough time or funding to run an Nth test in advance

Solution: apply RFM codes to your last completed outgoing promotion.

Since you know who responded, you can determine response rates by cell

Use previous rates to govern this rollout.

How Many RFM Cells Needed? Test File = (Test Budget) / (per piece cost)

Example = $15,000 / $0.76 = 19,737

Cells Needed = 19,737 / 274 = 72

Cell Division Determination To create 72 cells, some must

be less than 5 Recency most powerful. Do not

scrimp. Example R-F-M = 6 X 4 X 3 =

72 Is this best? Test and see.

RFM For Business Databases Business databases are small For small databases, use quartiles

or thirds Quartile = 4 X 4 X 4 = 64 Cells Thirds = 3 X 3 X 3 = 27 Cells Custom = 5 X 2 X 2 = 20 Cells

Recent Case History

User sells personalized product by mail

45,000 selected for a test

Second Recency Quintile Had More Responses.

Why?

Even so, First Recency Quintile Had Higher Sales

Recent buyers spend more per order

Lowest two recency quintiles did not break

even

Frequency was very predictive of response

Monetary did not predict response rate very well

But Monetary does predict average sales by quintile

RFM Cells clearly show who to mail to, and who to drop

When NOTNOT to use RFM

If you use it all the time, half your customers will never hear from you

They will be lost The others will suffer from File

Fatigue Use it sparingly Product launch is ideal use

THE COMPLETE DATABASE MARKETERby Arthur Middleton Hughes

Chicago: McGraw Hill 600 pp GlossaryRevised Edition 1996

This is the bible of database marketing. Over 16,000 copies sold. John Stevenson Exec. VP of Krupp Taylor: "Not only does this book succeed in being clear and accessible, it is also the first complete treatise...The full power and practice of database marketing are here, to be sure. This is the long awaited survival manual for every marketer on the cutting edge. I can't think of a book that is more rewarding."

This comprehensive book covers such subjects as how to build customer loyalty, lifetime value calculation, RFM analysis, customer service, telemarketing, fulfillment, hardware and software, clustering and profiling, prospecting, media selection. Order from www.DBMarketing.com

STRATEGIC DATABASE MARKETING 2nd Ed. by Arthur Middleton Hughes

Chicago: McGraw Hill 2000 400 pp

Millions have been spent on database marketing pro grams that did not work. In this book Arthur Hughes shows how to evaluate strategies in advance using life time value analysis. He explains how to use RFM analysis to boost profits. Russ Richmond, President of Grey Direct said: "Well, Arthur has done it again. He has not only integrated the complicated world of data bases with the traditional concepts of direct marketing, but he accurately points out the pitfalls and the how-tos. I know of a few careers that would have been saved had this book been available sooner. Without a doubt this will be the cheapest investment you'll make in your database, and perhaps the most important one." Thousands of customer marketing databases are being built. Unfortunately, many mistakes have been made. The reasons for these failures center on one central fault: the inability of marketers to develop logical, practical and winning strategies for their database marketing programs. We must study past mistakes to develop sound principles for marketing strategy. Order from www. DBMarketing.com

Thank You