Customer Segmentation

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Recap

✥ Three customer related information in CIF

✥ Steps requiring external interaction in I.D.I.C. framework
✥ Relationship between customer outreach actions, information & cost
of information collection R
C

Information
Face-to-

Medium
face
Telephone

Internet

Database

S
L Cost H
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Session Objectives

✥ By the end of the session, students are expected to:

※ Learn about customer valuation and customer management
techniques
※ Synthesize learning through case analyses

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Customer Segmentation methods

Customer
Segments

Primary Popular Strategic

Acquisition Share of
RFM
Cost Wallet

Share of
Retention CLV
Category

CE
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Customer Acquisition Rate / Cost

✥ Acquisition Rate (%)

※ First purchase or purchasing in the first predefined period
!"."$ %&'(")*+' ,%-&.+*/
※ * 100
!"."$ 0+"'0*%(' (,+1*(*/

✥ Acquisition Cost ($)

Acquisition spending ($)

※
Number of prospects acquired
※ Precise values for companies targeting prospects through direct mail
※ Less precise for broadcasted communication
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Retention and Defection

Number of customers in cohort buying in (t)| buying in (t−1)

✥ Retention rate (%) =
Number of customers in cohort buying in (t−1)
✥ Avg. Defection (Churn) rate (%)

= 1 – Avg. Retention rate

✥ If the average retention rate is 0.75 or 75% per year. i.e., on an average, 75% of
the customers remain customers in the next period. If a firm has 25,000
customers in Year 0 and average retention rate is 85% per annum, what is the
number of customers at the end of Year 3?
✥ (Number of acquired customers in cohort * Retention rate (n) )

YEAR 0 YEAR 1 YEAR 2 YEAR 3

25000 21250 18062.5 15353.13
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25000 * (0.85)^3 6
Retention Rate (Illustration)

Period Customer Base Customer Addition Retention Retention %

M1 100000 -
M2 110000 60000 50000 50000/100000 (50%)
M3 130000 50000 80000 80000/110000 (73%)
M4 135000 50000 85000 85000/130000 (65%)
M5 170000 60000 110000 110000/135000 (81%)

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Share of Category
✥ Share of Category
※ Measure of customer patronage for FMCG categories
※ Measures aggregate need fulfillment at segment level

Category Britannia Sunfeast Parle

Cookies Good Day, Nutrichoice Mom's Magic, Farmlite 20:20, Hide & Seek
Cracker Cream Cracker X X
Marie Marie & variants Marie & variants Marie & variants
Milk & Glucose Tiger, Milk Bikis Glucose Parle-G

Cream Jim Jam, Bourbon, Pure

Bounce Hide & Seek, Fab, Magix
Magic

Salt Time Pass, Maska Chaska Snacky Monaco

Sweet & Salt 50-50 Sweet & Salt Krackjack
Chocofils Pure Magic Dark Fantasy Milano
Rusk Britannia X Parle
Cake Cake X Happy Happy
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Bread Breads X X 8
Share of Wallet
✥ Share of Wallet
※ Firm’s share of customer spending across multiple categories
※ Measure of firm’s ability to cross-sell products

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Segmenting Customers: Share & Size of Wallet

High Maintain and guard

Hold on

Share-of-wallet

Target for
Do nothing additional selling

Low

Small Large
Size-of-wallet

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RFM (Recency, Frequency, Monetary Value)

✥ Recency, Frequency and Monetary Value-applied on historical data

✥ Recency -how long it has been since a customer last placed an
order with the company
✥ Frequency-how often a customer orders from the company in a
certain defined period
✥ Monetary value- the amount that a customer spends on an
average transaction
✥ Tracks customer behavior over time in a state-space

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Customer Life-Time Value

!
æ # ö
"
&"' = å $% ! ç ÷ - AC
! =# è #+ i ø

LTV = lifetime value of an individual customer in $, CM = contribution

margin, i = interest rate, t = time unit, Σ = summation of contribution
margins across time periods, AC = Acquisition Cost

LTV is a measure of a single customer / cohort’s worth to the firm

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Customer Lifetime Value

FY 2018 (Amount in Rs)

Expected
Customer Relation Acq. Cost
Cust ID
since (Yrs) (Rs) Avg. Profit Profit future
2019 2020 2021 2022 CLV
Revenue (Rs) (%) (Rs) Rel. (Yrs)

C1 2010 8 500 15000 20% 3000 4 2727 2479 2254 2049 12010
C2 2015 3 750 24000 15% 3600 2 3273 2975 9098
C3 2017 1 800 10000 15% 1500 4 1364 1240 1127 5231
C4 2014 4 600 22000 15% 3300 1 3300
C5 2016 2 500 40000 20% 8000 3 7273 6612 21885
19400 14637 13306 3381 2049 51524
Avg Retention Rate 5 years
Interest Cost 10%

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Customer Lifetime Value

!
LTV = m("#$%!)
where LTV = lifetime value, m = margin or profit from a customer per period, r =
retention rate (e.g. 0.8 or 80%), i = discount rate (e.g. 0.12 or 12%)

A firm has three cohorts. Calculate CLV using three infinite time period formulae and
compare results. Consider rate of interest @ 10%
MARGIN / CUST. AVG. ANNUAL AVG. RETENTION
SEGMENT
(Rs) SPEND (Rs) RATE (%)

X 1400 500 88%

Y 1900 750 82%
Z 2500 900 75%
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Customer Lifetime Value

Ø Situations for using different CLV / LTV formulae:

§ High value products – Impute all costs and calculate CLV
!
"
æ # ö
&"' = å $% ! ç ÷ - AC
! =# è # + i ø

§ Constant margins from business – Calculate retention rate

!
LTV = CM("#$%!)
§ Subscription based business – Margins visible at start of business
"#$
LTV = CM("#$%!) CM = Margin
§ Constant margins for perpetuity i = Discount rate
r = Retention rate
&'
LTV = $
t = time
AC = Acquisition Cost

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Customer Equity

✥ Customer Equity
!
% "
æ # ö
&( = å å &'$! ç ÷
$ =# ! =# è #+ ! ø

※ Sum of the lifetime value of all the customers of a firm

※ Indicator of how much the firm is worth at a particular point
in time as a result of the firm’s customer management
efforts
※ Can be seen as a link to the shareholder value of a firm
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Market Capitalization vs Customer Equity

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