Past and Current customer behavior is the best predictor of Future customer behavior

Customer Retention Models:

Data Needed: Sales data linked to each individual customer
Retention rate = Number of current customers/ Number of all customers
We look at every customer who has made at least 2 purchases and calculate the
number of days between the first and second purchases. This number is called
"latency" - the number of days between two customer events. Let us assume that to be
x days

We

can

cluster

the

customers

into

based

on

latency

Customers

Current
At Risk
Lost

We can find the Standard deviation of latency from the data of customers, call it d
If average latency of a customer in a month, l < x+ d, he is a current customer
If average latency of a customer in a month x+d < l< x+ 3d, he is a customer at risk

If average latency of a customer in a month l > x+3 d, he is a lost customer

The clusters of customers based on latency are mapped on to the three customer
segments, segment 1(Loyal to few products), segment 2 (Variety seeking people) and
segment 3 (Customers with longer relationship duration). Segment 2 customers at risk
are the ones that require highest attention followed by segment 1 customers at risk.
This identification helps to come up with promotional offers only to those that are of
maximum value to McDonalds.
For example, let's assume McDonalds has 1,000 customers, and they have an annual
budget of $1,000. They can spend $1 on each customer each year, and for that $1,
they get back $1.10 in profits. That's an ROI of 10%; now, if they knew spending $2
each year on a certain 50% of customers (identified above) would bring back $8 in
profits. That's a 400% ROI. Instead of spending $1 on each customer, if McDonalds
spends $2 on 50 % of its most profitable customers, they can have better results. They
spend the same $1,000 total and make back 500 (half the customers) x $8 = $4,000.
Also the clusters of current, at risk and lost customers can be further analyzed for
demographics to identify any trends and suggest promotions to McDonalds

Survival Analysis:
We can build a survival analysis model to measure the effect of number of purchases
made and the revenue from a customer on the retention of the customer.
To see how the retention probability changes, 2 categorical variables latency and
revenue per month are build from the available customer data.

lanency = 0 if calculated latency > X+ 3d ( X= mean latency , d= SD of latency)

1 if X+d < calculated latency < X+ 3d
2 if calculated latency < X+ d
revenue per month = 0 if calculated revenue < X+d ( X= mean revenue, d= SD of
revenue)
1 if X+d < calculated revenue < X+ 3d
2 if calculated revenue > X+ 3d
From the following graphs, we can see that,
Lower latencies are associated with higher probabilities of retention.
Higher latencies are associated with higher probabilities of retention.
We can also measure by how much the retention probability varies with increasing
revenues or decreasing latencies. By measuring the CLV (Customer Life time Value),
McDonalds can decide how much they should spend on promotions to retain the
customers who have higher probabilities of defection.
CLV can be calculated from the following formula,
CLV =MM T i=1( p i/(1+r / 12)i1)
Where
MM is the monthly margin for the last three months for existing customers, or the last
months monthly margin for newly acquired customer,

T is the number of months

r is the discount rate.
pi is the series of customer survival probabilities (customer survival curve) from month
1through Month T , where p1 = 1