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V. Kumar, University of Connecticut
In the past two decades, the firms tended to focus on either cost management or revenue growth. When a firm adopts one of these approaches it looses out on the other (Rust, Lemon, & Zeithaml, 2004). For instance, if a firm focuses only on revenue growth without emphasis on cost management, it fails to maximize the profitability. Similarly, cost management without revenue growth affects the market performance of the firm. What is needed is an approach which balances the two, creating market-based growth while carefully evaluating the profitability and return on investment (ROI) of marketing investments. Optimal allocation of resources and efforts across profitable customers and cost effective and customer specific communication channels (marketing contacts) is the key to the success of such an approach. This calls for assessing the value of individual customers and employing customer level strategies based on customers’ worth to the firm. The assessment of the value of a firm’s customers is the key to this customercentric approach. But what is the value of a customer? Can customers be evaluated based only on their past contribution to the firm? Which metric is better in identifying the future worth of the customer? These are some of the questions for which a firm needs answers before assessing the value of its customers. Many customer oriented firms realize that the customers are valued more than the profit they bring in every transaction. Customers’ value has to be based on their contribution to the firm across the duration of their 1
relationship with the firm. In simple terms, the value of a customer is the value the customer brings to the firm over his/her lifetime. Some recent studies (Reinartz & Kumar, 2003) have shown that past contributions from a customer may not always reflect his or her future worth to the firm. Hence, there is a need for a metric which will be an objective measure of future profitability of the customer to the firm (Berger & Nasr, 1998). Customer lifetime value takes into account the total financial contribution—i.e., revenues minus costs—of a customer over his or her entire lifetime with the company and therefore reflects the future profitability of the customer. Customer lifetime value (CLV) 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 with the company. In this chapter, we first discuss the importance and the relevance of CLV and compare it with other traditionally used metrics. Two approaches for measuring CLV, namely the aggregate approach and the individual level approach, are explained in the following section. The concept of P (Active) as the probability of customer being active in the future is also introduced in this section. In the subsequent section, we discuss the antecedents of CLV followed by a detailed discussion about how CLV measure can be used for developing customer-centric strategies with specific applications of using CLV to maximize ROI and/or profitability. We also present organizational challenges in implementing CLV-based framework and we conclude the chapter by discussing the future of CLV.
Why Is CLV Relevant and Important?
CLV is a measure of the worth of a customer to the firm. Calculation of CLV for all the customers helps the firms to rank order the customers on the basis of their contribution to the firm’s profits. This can be the basis for formulating and implementing customer specific strategies for maximizing their lifetime profits and increasing their lifetime duration. In other words, CLV helps the firm to treat each customer differently based on their contribution rather than treating all the customers same. Calculating CLV helps the firm to know how much it can invest in retaining the customer so as to achieve positive return on investment. A firm has limited resources and ideally wants to invest in those customers who bring maximum return to the firm. This is possible only by knowing the cumulated cash flow of a customer over his or her entire lifetime with the company or the lifetime value of the customers. Once the firm has calculated CLV of their customers, it can optimally allocate its limited resources to achieve maximum return. CLV framework is also the basis for purchase sequence analysis and customer specific communication strategies. CLV can be considered as the metric which guides the allocation of resources for ongoing marketing activities in a firm adopting customer-centric approach.
Traditionally Used Metrics
Some of the commonly used metrics for computing customer value include RFM, Share-of-Wallet and Past Customer Value.
RFM stands for Recency, Frequency, and Monetary Value. This technique
utilizes these three metrics to evaluate customer behavior and customer value.
1. Recency is a measure of how long it has been since a customer last placed an order with the company. 2. Frequency is a measure of how often a customer orders from the company in a certain defined period. 3. Monetary value is the amount that a customer spends on an average transaction. Two methods are generally used for computing RFM. The first method involves sorting customer data from the customer database, based on RFM criteria and grouping them in equal quintiles and analyzing the resulting data. The second method involves the computation of relative weights for R, F, and M using regression techniques and then the use of those weights for calculating the combined effects of RFM. RFM can be considered as the sum of the weighted recency, frequency, and monetary value scores for a customer.
Three customers have a purchase history calculated over a 12-month period. For every customer numerical points have been assigned to each transaction according to a historically derived R/F/M formula. The relative weight based on the importance
assigned to each of the three variables, R, F and M on the basis of an analysis carried out on past customer transactions is as follows: Recency-50%, Frequency- 20%, Monetary Value– 30% Table 29.1a about Here Table 29.1b about Here Table 29.1c about Here Table 29.1d about Here
In the above example MAGS has highest RFM score (i.e. 30.4) and is preferred to other customers for resource allocation if we use RFM method. RFM technique can be applied only on historical customer data available and not on prospects data.
Share-of-Wallet at an aggregate level is defined as the proportion of category value accounted for by a focal brand or a focal firm within its base of buyers. At an individual customer level, SOW is defined as the proportion of category value accounted for by a focal brand or a focal firm for a buyer from all brands that the buyer purchases in that category. It indicates the degree to which a customer meets his needs in the category with a focal brand or firm (Kumar & Reinartz, 2005). It is computed by dividing the value of sales (S) of the focal firm (j) to a buyer in a category by the size-of-wallet of the same customer in a time period. SOW is measured in percentage. Individual Share-of-Wallet (%) of firm to customer (%) = Sj / Where: S = sales to the focal customer j = firm
represents the summation of the value of sales made by all the J firms that sell a
category of products to a buyer. For instance, if a consumer spends on an average $500 per month on groceries and $300 of her purchases is with Supermarket A, then supermarket A’s share-of-wallet for that consumer is 60% in that month.
is interested in calculating the past customer value of all its customers to identify their best customers.The information about a customer’s spending with competitors is not normally available with the firms. Past Customer Value of a customer = ∑ GCit * (1 + r ) t t =1 T Where i = number representing the customer r = applicable discount rate (for example 15% per annum or 1. t.25% per month) T = number of time periods prior to current period when purchase was made GCit = Gross Contribution of transaction of the ith customer in time period. However. The contributions from past transactions are adjusted for the time value of money and the cumulative contribution till the present period is the past customer value (PCV) of a customer. PCV can be computed using the following formula. The results are then extrapolated to the entire buyer base. Example: Consider an electronic retailer BB Corp. They have data 6 . Past Customer Value This model is built on the assumption that the past performance of the customer indicates their future level of profitability and an extrapolation of the results of past transactions is a measure of customer’s value in the future. The value of a customer is determined based on the total contribution (towards profits) provided by the customer in the past. This is obtained from primary market research or surveys administered to a representative sample of firm’s customers. in certain B-to-B contexts firms can infer the size of wallet for certain products especially when the number of players in the market is few.
The customers with higher values are normally the customers deserving greater marketing resources. Gross Contribution (GC) = Purchase Amount × 0. They can compare the value generated by each customer by computing all transactions in terms of their present value. Table 29.25% per month.3 Past Customer Value Scoring = 6(1 + 0.01486 The above customer is worth $302. The gross margin is 30% of the purchase amount and discount rate is 15% per year or 1. and monetary value of a customers purchase explain the future value of the customer. Past Customer Value.2 about Here The Past customer value of this customer is then computed as follows. These measures consider only the observed purchase behavior and extrapolate it to the future to arrive at the future profitability of a customer.on the products purchased by various customers over a period of time.0125) 3 + 15(1 + 0. the value of the purchases and the contribution margin. and Share-of-Wallet are commonly used for computing customer’s future value.0125) + 9(1 + 0. expressed as net present value in May in dollars. Difference Between CLV and the Traditionally Used Metrics Though RFM. It fails to account for other factors which help in predicting 7 .0125) 4 + 240(1 + 0.0125) 5 = 302. frequency. RFM assumes that the recency. The spending pattern by one of their customer is given below. By comparing this score among a set of customers we arrive at a prioritization for directing future marketing efforts.0125) 2 + 15(1 + 0. they suffer from the following drawbacks. These methods are not forward looking and do not consider whether a customer is going to be active in the future.01 in contribution margin.
Measuring CLV Lifetime value of a customer can be either calculated as an average CLV or individual level CLV. PCV technique also fails to account for factors influencing future purchase behavior of customers. and SOW approaches do not take into account the probability of being active in the future and the costs whereas CLV approach incorporates both these aspects in the calculation as can be seen in the next section. we need to know whether the customer is going to purchase in future time periods and the expected value of profits he/she brings to the firm. This limits its use as a valuable input in designing customer level marketing strategies. On the other hand. CLV can be effectively used as a metric in allocating resources optimally and developing customer level marketing and communication strategies. one goal of calculating the value of a customer is to design customer level strategies so that firms can maximize their return. and M greatly influence the computation of customer’s worth. 8 . Also. As discussed above.customer’s future purchase behavior and his/her worth to the firm. RFM. It also does not incorporate the expected cost of maintaining the customer in the future. F. PCV. To effectively do this. We should also know the effort or marketing costs to be spent to retain the customer. CLV measure incorporates both the probability of a customer being active in the future and the marketing costs to be spent to retain the customer. it is unable to provide us a clear indication of future revenues and profits that can be expected from a particular customer. Since SOW measure is based on responses from a representative sample of customers. the weights given for R.
the CE measure gives the economic value of a firm and we can calculate average CLV by dividing CE by the number of customers. In this case. Three approaches to arrive at average CLV are explained here. 1998. Kumar & Ramani. ⎡ (GC − M ) t ⎤ CLV1 = ∑ ⎢ r ⎥−A t 1 t =0 ⎣ ( + d ) ⎦ T (2) where r = rate of retention 9 . average lifetime value of a customer is derived from the lifetime value of a cohort or segment or even the firm. 2004) the average CLV of a customer is calculated from the lifetime value of a cohort or customer segment. the sum of lifetime values of all the customers. In the first approach. called Customer Equity (CE) of a firm is calculated as. In another approach (Berger & Nasr. i = customer index t = time period T = the number of time periods for which CE is being estimated. The average CLV of a customer in the first cohort or cohort 1 can then be expressed as.An Aggregate Approach In the aggregate approach. CE = ∑ i =1 I ⎛ 1 ⎞ ∑ CM it ⎜ 1 + δ ⎟ ⎠ ⎝ t =1 T t (1) where CE = customer equity of customer base in $ (sum of individual lifetime values) CM = Contribution margin in time period t δ = discount rate.
Customers leave the relationship with the firm in different points in time the retention probabilities vary across customers. This is expressed in a mathematical equation as follows. and marketing cost (M) per customer. r is the average retention rate for the cohort and is taken as a constant over a period.t ρ i.t + k ⎟(S i .r .t + k )⎜ ⎟ ⎥ ⎜ ⎟ ⎝1+ d ⎠ ⎥ i =0 ⎢ k =1 ⎝ j =1 ⎠ ⎣ ⎦ where CE(t) = the customer equity value for customers acquired at time t Ni.t − ci .t Bi.tα i .t + k − Bi . However this is not the case in reality. (Blattberg.d = discount rate or the cost of capital for the firm. k I ⎡ ∞ ⎛ k ⎞ ⎛ 1 ⎞ ⎤ CE (t ) = ∑ ⎢ N i .a. The retention rate.tα i .t + k − Bi .t 10 . return on retention and return on add-on selling. & Thomas. the average acquisition cost per customer (A). t = time period T = the number of time periods considered for estimating CE.t + ∑ N i . M = marketing cost per customer A = the average acquisition cost per customer This approach takes into account only the average gross contribution (GC).t Bi . This means that we have to account for retention probabilities in the calculation for CE.t = the number of potential customers at time t for segment i = the acquisition probability at time t for segment i = the retention probability at time t for a customer in segment i = the marketing cost per prospect (N) for acquiring customers at time t for segment i α i.t (S i . GC = the average gross contribution. In another approach.t ⎜ ∏ ρ j . a .t + k − ci . Getz. AO . 2001) customer equity of the firm is first calculated as the sum of return on acquisition.t ) − N i .
In the absence of competitors’ customer level data. marketing and advertising spending by competing firms to arrive at reasonable estimates of average CLV for competitors.t I I t0 = the marketing in time period t for retained customers for segment i = discount rate = sales of the product/services offered by the firm at time t for segment i = cost of goods at time t for segment i = the number of segments = the segment designation = the initial time period.Bi. One of the important application of average CLV (Gupta & Lehmann. firms can deduce information from published financial reports about approximate gross contribution margin. Average CLV can then be arrived at by dividing CE by the number of customers. which is the basis for developing customer specific strategies. average CLV has limited use as a metric for allocation of resources across customers because it does not capture customer level variations in CLV.r.t ci. 2004) is for evaluating competitor firms. Hence it is necessary to calculate CLV of individual customers in order to design individual level strategies. aggregate CLV of a firm or customer equity may be used as surrogate measure of firm’s market value.AO.t = the marketing costs in time period t for add-on selling for segment i Kumar & Ramani. Average CLV approach can also be used for assessing the market value of the firm.t d Si. Individual-level Approach 11 . Bi. However. 2003. Gupta and Lehmann demonstrated that for high growth companies. This gives an idea of how profitable or unprofitable are competitors’ customers.
NPV of EGCit = n = t +1 ∑ P( Active) t+x in × AMGCit (1 + d )n AMGCit = average gross contribution margin in period t based on all prior purchases i = customer index 12 . and d = discount rate. 2003).At an individual level. To calculate the future contribution from a customer in a non-contractual setting. we can first get the net present value (NPV) of expected Gross Contribution (EGC) as (Reinartz & Kumar. CLVi = ∑ where (Future contribution marginit − Future cos tit ) (1 + d )t t =1 T (4) i = customer index. It is a function of the predicted contribution margin. customer lifetime value is calculated 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 with the company. t = time index T = the number of time periods considered for estimating CLV. CLV can be expressed as. The CLV has two components. the propensity for a customer to continue in the relationship. and the marketing resources allocated to the customer. In its general form. a firm should know the probability that the customer continues to do business with the firm in future time periods or probability of customer being active. Taking into account this probability. P (Active). future contribution margin and future costs both adjusted for the time value of money.
For instance. and DVDs. AMGC = (240+15+15+9+6)/5 = 57 NPV of EGC = 0. AMC Inc.40 and that in July is 0. In the next four months he purchased some software. Marketing costs in future time period need to be discounted with appropriate discount rate. the customer purchased a desktop PC in January for $800. 13 .125)2 57 = 28.t = the period for which NPV is being estimated x = the future time period n = the number of periods beyond t d = Discount Rate P (Active) in = the probability that customer i is active in period n Example The spending pattern by a customer of an IT company. we can express CLV as.125) 57 1 + 0. d to arrive at the present value of these costs. If the marketing costs are accounted at the beginning of a given time period and the gross contribution at the end of time period.25% per month. flash memory.82 Costs include acquisition cost (A) and the marketing costs (M) in future time periods. P(Active) in June is 0. then the NPV of EGC for June and July for this customer can be calculated as follows.19.3 about Here If the probability of customer being active.4 × (1 + 0.19 × (1 + 0. Table 29. is given as follows. The average gross margin is 30% of the purchase amount and discount rate is 15% per year or 1. The discounted marketing costs (M) and the acquisition cost (A) are then subtracted from the NPV of ECG to get the CLV of a customer.
Estimation of marketing cost is important in arriving at optimal customer specific communication strategies. Discount Rate (d) The revenue or gross contribution from the customer comes at different time periods in the future. or weekly. cost of loyalty or frequent flyer programs. and the cost of serving the customer accounts. To arrive at marketing costs specific to a customer. firms need to estimate the number of contacts required to retain the customer and the cost of contact through various channels. monthly. cost of campaigns to ‘win back’ the lost customers. The contacts through different channels have different costs to the firm. This is calculated based on his/her past purchases.CLV of customer i = n = t +1 ∑ t+x P( Active)in × AMGCit (1 + d )n x ⎛ 1 ⎞ − ∑ M in × ⎜ ⎟ ⎝1+ d ⎠ n =1 n −1 −A Average Monthly Gross Contribution (AMGC) The average monthly gross contribution. For example. One main component of these costs is the cost of marketing contacts through various channels of communication. The value of money is not constant across time and since the money received today is more valuable than the received in future time periods. the GC and marketing costs have to be discounted to the 14 . It can be the cost of programs to increase the value of existing relationship. Marketing Cost (M) This includes the development and retention costs. a face-to-face meeting with customer costs much higher than communication through direct mail or e-mail. AMGC is the average monthly revenue obtained from a customer minus the average cost of goods sold. accounted yearly. Once firms have such cost accounting. calculation of marketing cost is straightforward.
present value of money. and so on) It is therefore important to make an educated judgment as to what is a sensible duration horizon in the context of making decisions. For most businesses it is reasonable to expect that the customers will return for a number of years (n). For all practical purposes. sometimes only 2 years. it also seems strange to talk about LTV of a grocery shopper. where d is the discount rate. any calculation and prediction may become difficult due to so many uncontrollable factors (the customer moves. the lifetime duration is a longer-term duration that is managerially useful. There are no strict guidelines to decide on the value of n. Time Period (n) The number of future time periods (n) for which the gross contribution and the marketing costs are considered for calculation of CLV refers to the natural ‘lifetime’ of the customers. The discount rate. The word “lifetime” must be taken in many circumstances with a grain of salt. However. managers consider maximum 4-year time span. Beyond that. this probability 15 . in a direct marketing general merchandise context. It can also vary across firms depending upon the cost of capital to the firm. While the term makes little sense with one-off purchases (say. for example. For example. a new competitors moves in. this actual value has not much practical value. given the long time span. a house). there is an actual lifetime value of a grocery shopper. P (Active) in is the probability that the customer continues to be active in subsequent time period. For CLV calculation to be at an individual level. This is achieved by dividing the cash flow in time period i by (1+d)i. Clearly. d depends on the general rate of interest and is normally proportional to the Treasury bill or the interest that banks pay on savings accounts.
who bought four times in the first eight months and did not buy in the next four months. for a customer. other sophisticated methods are employed for the calculation of the probability of a customer purchasing in future time periods. he/she does not come back to the firm. For illustration. One drawback of using P (Alive) to predict customer’s future activity is that it assumes that when a customer terminates a relationship.of retaining customer has to be calculated at an individual customer level rather than the average rate of retention at the firm level. Figure 29. P (Active) in month 12 = (8/12)4 = 0. at the end of month 12) is less than that of customer 2 who purchased only two times in the first eight months. T is the time elapsed between acquisition and the most recent purchase. This approach called “lost-for-good” is questionable because it systematically 16 .444 where n=2 In the above case. Each customer is likely to have different purchase patterns and their active and inactive periods vary as shown in the Figure 29. However. and N is the time elapsed between acquisition and the period for which P (Active) needs to be determined.1 about Here Given their purchase behavior in the past. if indicates a purchase.e.197 where n=number of purchase = 4 P (Active) for customer 2 in month 12 = (8/12)2 = 0. The formula introduced here for calculation of P (Active) is very basic. A Simple formula to calculate P (Active) is P (Active) = (T / N)n Where n is the number of purchases in the observation period. the probability of purchase after 4 months (i.1. one can predict the probability of individual customers being active or P (Active) in subsequent time periods. then for customer 1.
In this case. predicting the frequency of a customer’s purchases given his or her previous purchase is a better way of projecting future customer activity. which takes into account the possibility of a customer returning to the supplier after a temporary dormancy in a relationship (Venkatesan & Kumar.underestimates CLV (Rust. and = predicted number of purchases made by customer i until the end of planning period.m. The CLV function which incorporates predicted frequency can be expressed as follows1.m. 2004). frequencyi = predicted purchase frequency for customer i. number of marketing contacts and the marketing costs in different channels are as follows: 17 . CLVi = ∑ y =1 Ti CM i . To overcome this. researchers use “always-a-share” approach.l xi. y (1 + r ) y frequencyi −∑ l =1 n ∑ m (1 + d )l −1 ci . d ci. Lemon.l × xi . CMi. = unit marketing cost for customer i in channel m in year l. & Zeithaml. = number of contacts to customer i in channel m in year l. This predicted frequency can be used to calculate CLV. m.y = predicted contribution margin from customer i in purchase occasion y. 2004). n Ti = number of years to forecast.l = discount rate. Example Suppose the predicted contribution from a customer in purchase occasions in next two years.l where CLVi = lifetime value of customer i. m.
.Time period Predicted contribution ($) Number of direct mails: Jan ‘05 100 May‘05 70 Year 1 = 4 Year 1 = 2 2.5 × 4) + (3 × 3)⎫ = $319... purchase sequence analysis.5 × 4) + 3 × 2 + (1 + 0.15) ⎧ (2. and for targeting right customers for acquisition.50 3.15) ⎬ ⎭ ⎩ Various supplier-specific factors (channel communication) and customer characteristics (involvement. it can also be used for formulating other customer-level strategies such as customer selection. switching costs. then CLV of this customer can be calculated as given =3 30 63 (1 + 0. 18 . Purchase frequency and contribution margin are then modeled separately using suitable models..00 Nov‘05 50 Feb ‘06 90 Jul ‘06 65 Oct ‘06 30 Year 2 = 4 Year 2 = 3 Number of contacts via telephone: Cost per direct mail ($) Cost per contact via telephone ($) below. and previous behavior) are first identified as the antecedents of purchase frequency and contribution margin.. which is the basis for optimal allocation of marketing resources across channels of contact for each customer so as to maximize his or her respective CLVs. In addition to using the CLV framework for resource allocation strategy.15) 100 13 + . + (1 + 0.05 − ⎨(2. The CLV model described above can be employed to identify the responsiveness of customers to marketing communication through different channels of communication.. Predicted purchase frequency CLV = If the discount rate is taken as 15%. In the framework developed by Venkatesan and Kumar (2004) a generalized gamma distribution is used to model interpurchase time and panel-data regression methodologies are employed in modeling the contribution margin...
they are also keen on identifying the factors that are in their control that could increase the value of their customers. Customers living in areas with lower 19 . The antecedents of profitable lifetime duration are grouped as exchange characteristics and customer heterogeneity. Drivers of CLV While firms are interested in knowing the lifetime value of their customers.4: Table 29.As can be seen from the CLV calculations. cross buying behavior. This is especially important in a non-contractual setting because customer has the freedom to leave the relationship anytime. Hence it is very important for a firm to understand the factors influencing the profitable duration of customer with the firm or the drivers of profitable lifetime duration. Different exchange characteristics that are identified as positive drivers of profitable lifetime duration in a B-to-C and B-to-B contexts include customer spending level. The relationship of these drivers with CLV as observed in the above mentioned study is given in Table 29. The exchange characteristics define and describe the nature of customerfirm exchange where as demographic variables capture customer heterogeneity. focused buying. Reinartz and Kumar (2003) identified the factors which explain the variation in the profitable lifetime duration among customers. the lifetime value of a customer depends to a great extent on whether the customer is going to be active in the future time periods or not.4 about Here The average interpurchase time for customers exhibited an inverse U-shaped relationship with profitable lifetime duration. customer’s ownership of loyalty instrument and the mailing efforts by the firm.
Also. based on the expected response from each customer to available marketing 20 . Customer management from the perspective of CLV can be defined as “the process for achieving a continuing dialogue with customers.population density or businesses operating in lower population density had higher profitable lifetime duration. Dynamic customer management based on CLV can improve the shareholder value. across all available touch points. Firms can use CLV framework to identify which customers are most likely to bring maximum profit to the firm in the future. Drivers of profitable lifetime duration/CLV are important inputs for resource allocation strategy and purchase sequence analysis. through differentially tailored treatment. and the optimal level of resource allocations to various channels of communication. Identification of antecedents of profitable lifetime duration enables managers to take specific actions to improve the drivers and thereby the profitability from the customers. the income of the customer (B-to-C) or the firm (B-toB) had positive relationship with profitable lifetime duration. CLV is a metric. How Can CLV Measure be Used for Developing Customercentric Strategies? Calculation of CLV for all its customers is only the first step firms can take to implement customer level strategies. which can be a basis for firm’s investments in infrastructure and ongoing marketing activities. Managers can also identify customers who are likely to be profitable in the future and decide when it is worthwhile to stop investing in a customer by analyzing the antecedents of profitable lifetime duration with respect to specific customer. what are the factors leading to higher CLV.
1997. Customer Selection Recent research (Dowling & Uncles. These strategies help to maximize the profitability and customer equity of the firm. 21 . Specific Applications of Using CLV to Maximize ROI and/or Profitability Recent academic literature (Kumar & Petersen. 2000) has shown that not all loyal customers are profitable.” (Kumar & Ramani. is then an important step in improving the profitability. (3) optimal resource allocation. Specifically these strategies include: (1) customer selection. 2003). (4) purchase sequence analysis. (2) customer segmentation. and (5) targeting profitable prospects. The success of a firm in exploiting a CLV framework lies in firm’s ability in identifying and implementing the most effective customer level marketing decisions based on CLV metric so that the future profit from the customer is maximized. Selection of right customers to retain. who bring maximum profits to the firm. This research questions the reasoning that retaining more number of customers increases the overall profitability of the firm. This is because the contributions from many customers are far less than the cost incurred by the firm to retain them. These strategies will have a strategic impact of increasing the customer lifetime duration and the lifetime value.initiatives. Reinartz & Kumar. thereby increasing the shareholder value. They also have strategic impact on profitable lifetime duration of the customers. Acquiring and retaining such unprofitable customers can only act as a drain on the overall profitability. 2005) have shown evidence that CLV can be used to generate customer level strategies and optimize firm performance. such that the contribution from each customer to overall profitability is maximized.
CLV calculation. 50%. Reinartz and Kumar (2003) used data from a U S general merchandise catalog retailer for 11. These studies have also showed that CLV is superior to RFM method in predicting future profits and purchase behavior of customers. Reinartz and Kumar (2000. This clearly shows that CLV is a better metric in selecting the most profitable customers. advanced RFM. and Past Customer Value (PCV).991) was much higher than profits from top 30% customers selected by either advanced RFM ($27. These three customer selection methods are then compared based on the actual revenue and profit generated in the remaining time period by the top 30%. This is explained by the fact that the profit generated by top 30% customers selected by CLV method ($62. they ranked the customers using three methods: NPV of ECM (CLV method). The results were similar for other two groups (top 50% and top 70%) also. which takes into account the future profits from a customer.916). Based on information up to 30 months.5.992 households over 36 months.How can then a firm identify the right customers to retain? Are they the ones who bring maximum revenue to the firm? Research shows that this need not be the case.5 about here CLV method (in this case NPV of ECM) selected the most profitable customers. Table 29. Firms need a measure of profitability of each customer to decide who their best customers are. and 70% of customers selected by each method. comes in handy here. 2003) have shown that determining lifetime value of each customer and the customer and firm specific drivers of profitable customer lifetime duration help the firms to identify the right customers to retain. The support for superiority of CLV in customer selection is further strengthened by a recent study by Venkatesan and Kumar (2004) 22 . The results are given in Table 29.582) or PCV ($35.
They compared the customer selection capabilities of the following: CLV. variable costs of communication. previous period customer revenue (PCR).6 about Here The average net profits of top 5% customers selected using CLV was $143. These variables explain why certain customers are more profitable than others. and profits for the top 5%. compared to the average net profits of $70. The actual sales.using data from a large multinational computer hardware and software manufacturer. PCV. and customer lifetime duration (CLD).929. In order to do customer segmentations. past customer value (PCV). 10%. The results were similar for top 10% and 15% of customers as well. and $106.295. and 15% customers (selected using different customer selection methods) for 18 months prediction window are compared and the results are provided in Table 29. and CLD. firms need to understand the exchange variables and customer demographic variables which differentiate each group from the other. These results from two separate studies using database from B-to-C (catalog retailer) and B-to-B (computer hardware and software manufacturer) firms provide substantial support for the superiority of CLV framework over other metrics for customer scoring and customer selection.389 for the top 5% of the customers selected on the basis of PCR. The study was similar to the earlier study by Reinartz and Kumar (2003).785. Though customer level marketing actions are the desired outcome of CLV computation it is also worthwhile to look at specific segments of customers based on CLV and develop strategies for each segment. Customer Segmentation Differential treatment of customers is the key to manage the customer relationship profitably. Table 29.6. Reinartz and Kumar (2003) studied the 23 . $130.
degree of cross buying. The customer profile analysis can be used to identify the segments on which firm should concentrate on their marketing efforts and to tailor the most suitable marketing messages to these segments. which are drivers of customer lifetime duration and CLV. location and income of customers. For instance. and how frequent their best customers buy from them. mailing effort by the firm. Each of these variables has different impact on the customer lifetime duration and possibly on CLV. and the relationship between average interpurchase time and profitable lifetime duration was inverted U-shape. Profiling helps the firms to understand the characteristics of their best customers. average interpurchase time. the customers are first grouped into deciles or demideciles on the basis of their CLV scores. Some of the key variables found in the study were amount of purchase. firms can identify segments which are low on the number of touches on an average and target those 24 . what are the best means of communication or touch channel to reach their best customers.exchange and demographic variables that affect the lifetime duration of customers in a non-contractual setting. Profiling helps to better understand the customer composition of each segment. In practice. The profile of these deciles/demideciles or a segment (a set of deciles/ demideciles) are then analyzed. number of product returns. We can therefore profile the customers based on various exchange and demographic/ firmographic variables. how do they want to do business with the firm. degree of cross buying was found to have a positive relationship with customer lifetime duration. if number of marketing touches is found to be a key driver of high CLV. ownership of loyalty instrument. in a study of catalog retailer. number of returns had an inverted U-shape relationship with lifetime duration. For instance. degree of focused buying.
7 contains the description of each group and the actionable marketing strategies to maximize CLV for customers in each group. Another useful segmentation for the firms is grouping based on historical profits and future profitability of customers.8 shows the customer segments as per this segmentation scheme. Table 29. ‘True Friends’ is the segment which firms should identify to spend maximum of their marketing resources in order to nurture and strengthen the customer relationship. First of this segmentation schemes groups customers into four distinct cells based on High/Low values for customer lifetime profits (CLV) and customer relationship duration. Such segment level marketing actions to improve the drivers of customer lifetime value coupled with customer level strategies on marketing communication can thus improve the CLV of the segment. Table 29. Table 29.7 about Here The ‘Butterflies’ may become ‘True Friends’ or ‘Barnacles’ in the long run.segments in increasing the number of marketing touches through the most effective channels thereby improving the profitability of the segment. It is not worthwhile to spend marketing dollars on ‘Strangers’ or ‘Barnacles’ with small size-of-wallet. Hence companies should be watchful of the inflection point beyond which investing on them may result in overspending. 25 . CLV along with other customer value metrics can be used to segment customers into four different groups as shown in two segmentation schemes discussed below. Firms should aim for achieving attitudinal and behavioral loyalty of this segment through consistent intermittently spaced marketing communications.
These are only some of the segmentation schemes firm can follow. Firms should target them for cultivating attitudinal loyalty and should upsell or cross-sell to them so that they can be converted into ‘True Loyalists’ and not “Falling Angels’ in the long run. invest in them to strengthen the relationship. and to achieve high positive attitudinal loyalty. The relationship with them needs to be strengthened. ‘Rising Stars’ displays high future profit potential (high CLV) even though their historical profits are low. Firms can use CLV with any other loyalty metric and come up with customer segmentation most suitable to the firm or type of business. to retain them. Firms have to reward them proactively. It is not worth investing on developing strong relationship with them. Firm’s aim should be to extract maximum profit from every transaction probably by migrating them to low cost channels. Identifying specific up-sell or cross-sell opportunities may help to bring some of them back to the high profitability path once again. ‘Total Misfits. Firms should be wary of investing too much on them based on their past profits but should try to optimize (minimize) marketing cost by transacting through low-cost channels.8 about Here ‘True loyalists’ are customers who have high PCV or historical profits and have high profit potential in the future (High CLV) as well.Table 29. ‘Falling Angels’ are customers who contributed significantly to the profitability of the firm in the past but are not expected to do so in the future for various reasons. Optimal Resource Allocation 26 .’ whose contribution to the firm’s profitability is low in the past and in the future should be dealt with very cautiously.
the firms are constrained by a limited budget and the resources are not adequate to allocate to all its customers. 2004). researchers have now come up with models that allow customer level actions. promotion expenditures (Berger & Bechwati. Venkatesan & Kumar. marketing actions when future brand switching is considered (Rust. and how much resource to be spent on them to maximize the profitability. As discussed in CLV measurement section. optimal resource allocation.In most cases. Blattberg. 2001. Previous research on optimal resource allocation have addressed the resource allocation in acquisition and retention decisions (Blattberg & Deighton. However many companies continue to spend resources on large number of unprofitable customers (Venkatesan & Kumar. & Zeithaml. This model will help a manager to know the extent to which he/she should use various contact channels to communicate to a customer and optimize the allocation of resources across channels of communication for each customer. 2001. predicted contribution margin and marketing costs. Getz & Thomas. the equation for calculating CLV is a function of predicted purchase frequency. Ideally. 2004). 1996. Lemon. 1998). We addressed the first issue in the customer selection section. The Inter-purchase time for a customer is 27 . Optimal allocation of resources on an individual customer level was not feasible before the introduction of the customer value framework. The second issue. One reason for this is that these firms have not identified who their most profitable customers are. By utilizing the customer value framework. Berger & Nasr. so as to maximize CLV. thereby leading to wastage of limited resources. 2004). can also be addressed using CLV metric. firms should be investing only on customers who are profitable. They would either be investing on customers who are easy to acquire but are not necessarily profitable or are trying to increase the retention rate of all their customers.
An optimization technique can be utilized to accurately arrive at the differential allocation of strategic resources to individual customers across a variety of integrated marketing strategies (Venkatesan & Kumar. the expected Inter-purchase time and the cost and frequency of the marketing contacts employed. A probability based model that predicts the inter-purchase time of each customer. The CLV of a customer is then related to the cash flow from each customer. Using these coefficients. The first step in optimization is estimating the responsiveness of customers to marketing contacts on CLV with respect to individual customers. The contribution margin model predicts the cash flows from each customer in the future time periods and the marketing costs to be spent on the customer. the level of channel contacts for each customer which maximizes the CLV can be determined. 2004) uses this CLV equation as the objective function to arrive at the optimal level of contacts across various channels with each individual customer that would maximize CLV. The purchase frequency model calculates the inter-purchase time as a function of nature of marketing and communication efforts. 28 . 2004). A manager can determine the frequency of each of the available marketing and communication strategies such that the NPV objective function is maximized. A recently developed model for optimizing resource allocation (Venkatesan & Kumar. as a function of marketing communication inputs and the customers’ past purchase behavior observed over time.influenced by marketing initiatives that a firm takes. The objective function is thus based on three elements: 1.
They compared the net present value of future profits for a large Business-to-Business (B2B) manufacturer when the resource allocation strategy is employed vis-a vis the NPV of future profits when the firm used the current resource allocation strategy. This illustrates that it is possible to increase the profit and return on marketing communications by proper customer selection and by optimal allocation of resources across different channels of communication for each customer based on CLV. CLV calculated for three years based on the current resource allocation strategy among a sample of 216 customers. also as a function of marketing communication inputs and the customers’ past purchase behavior observed over time 3.188 and in the optimal resource allocation strategy it was $1 million.188) in the current strategy to 44 ($44 million/$1 million) in the optimal strategy. The increase in profit was 48% and the return on marketing communication increased from 34 ($24 million/$716.2. Managers can therefore make use of the optimal resource allocation algorithm to design more effective marketing communication strategies across various channels and to 29 . an increase of 80%. The total cost of communication in the current strategy was approximately $716. was $24 million whereas when the optimal resource allocation strategy as explained above was used the CLV for three years was $44 million. An optimization algorithm that maximizes the profits from each individual customer by examining the impact of various levels of marketing communication inputs The study by Venkatesan and Kumar (2004) illustrates the effectiveness of resource allocation strategy. A panel data model that predicts the cash flows from each individual customer.
The resource allocation strategy can be a basis for evaluating the potential benefits of implementing CRM and it provides accountability for strategies geared toward managing customer assets. These recommendations are based on the products purchased in the past by a particular customer by customers who bought same products. The more accurately these product recommendations match customer’s preferences. But from the firm’s point of view this is a very valuable piece of information because firm can then decide the message and timing of customer specific communication strategy. Purchase Sequence Analysis In a multi-product firm it is not easy to speculate what product a particular customer is going to buy next. Therefore. Companies such as Amazon try to predict what you are most likely to buy given your past purchases and preferences and then make suitable product recommendations to customers. An ideal contact strategy is one where the firm is able to deliver a sales message that is relevant to the product that is likely to be purchased in the near future by a customer.improve the CLV of their customers. a firm that knows when and what a customer is likely to purchase next can have a significant advantage over the competition. a firm should find answers to the following questions about its customers: What is the sequence in which a customer is likely to buy multiple products or product categories? When is the customer most likely to make the next purchase? What is the expected revenue from that customer? 30 . the more likely the customer is to make another purchase with Amazon. In order to predict customer’s future purchase.
A purchase sequence model developed by Kumar. there are interdependence in product purchases and similarity in purchase pattern of customers. or because of word-of-mouth effects (Bikhchandani et al. allowing the firm to model behavior and predict the likelihood of purchase timing and sequence. Using customer data from a B2B firm.. and Reinartz (2005) were able to demonstrate the effectiveness of purchase sequence model. a printer and software purchases follow that of a computer. companies can to a certain extent incorporate this natural sequencing of purchases to draw inferences about what a customer is likely to buy next given the logical path of purchasing. which markets multiple categories of products. The 31 . Venkatesan. Venkatesan. purchases of accessories follow the main product and the like. Purchases of certain products are dependent on the product purchases in the past. they follow similar purchase sequence as past customers. whom they trust. In other words there is a natural ordering of purchasing in some cases. Kumar. For example. As a result. Consumers also seem to follow purchase patterns similar to other consumers. 1998) resulting from communication with other customers. The basic theory behind this framework is that often times. Therefore. The results indicate that the model is able to prioritize customers by indicating the propensity to purchase different products for each of its customers. This is either because they observe purchasing by other customers. the consumer chooses to purchase a product or a series of products relying on the information processed by customers whom they trust. and Reinartz (2005) offers a framework to analyze the purchase sequence and timing of each customer. It also predicts the expected profits and there were significant improvements in both profitability and ROI over the firm’s routine contact strategy. 1992. In either case.
They computed the purchase propensities of different customers for three products spanning across four quarters within a year. The firm can now contact customers with time specific and product specific offerings rather than having to contact the customers with multiple product offerings in each time period. generated by the test group of sales persons who adopted strategies based on the Purchase Sequence Model versus the control group of sales persons who were not provided the predictions given by the model. Based on these predicted purchase sequence firms can develop the marketing contact strategy. For example. They were also able to show that by implementing this targeted strategy (i. it is optimal to contact customer A in quarter 2 offering information regarding product #1. The purchase sequence for each customer can then be predicted using these propensities to purchase. and implement individual level strategies in order to maximize the profitability from its 32 . These results show that knowing the sequence and timing of purchases by individual customers will help the firm to develop more effective marketing strategy. using CLV framework. over the previous year. select.e. contacting the right customer with the right product at the right time) versus using a traditional strategy. if customer A has high propensity to purchase products #1 in quarter 2. there was an incremental gain in ROI of $2 for every $1 spent. Table 29. Targeting Profitable Prospects We discussed how firms can. prioritize.following table is an illustration of the improvement or growth in profit for the selected product category.92 about Here These findings were validated by Kumar and Petersen (2005) by applying the model to a B-to-C setting and achieving similar results.
2005). Blattberg and 33 . acquire them and nurture relationship with them. How can firms do this with limited information about their prospects? What are the most effective marketing campaigns to acquire profitable customers? The answer lies in the profile analysis of existing customers. Once a firm has profiled its existing customers. Firms can also use the profile analysis and the optimal resource allocation strategy to identify the communication strategy and marketing campaign and to efficiently manage their marketing budget when attracting new prospects. for a firm to grow it has to target prospect. it can profile its prospect pool and use archived customer information to find potential customers with matching profiles as those customers who currently have positive lifetime values with the firm. The challenge here is to identify the best prospects. Firms therefore need to determine which prospects are worth chasing and also which dormant customers are worthwhile to win back (Kumar & Petersen. Thomas (2001) showed that firms need to link acquisition efforts to retention efforts to avoid underspending and overspending on acquisition or retention. what channels of communication are most suited for them. However. These prospects with characteristics similar to the existing high CLV customers are most likely to become high-value customers in the future. This is very important because acquiring an unprofitable customer will only add to the cost in the long run while on the other hand. what their demographic variables are. who when acquired will bring maximum value to the firm. not acquiring a profitable customer will be a lost opportunity.existing customers. and what marketing campaigns are most effective to win them. Customer profile analysis and segmentation tell us who our best customers are. Most firms consider that acquisition and retention are two independent activities.
10 that highest rate of retention (in terms of relationship duration) is achieved with an investment of $70 per customer. Reinartz. Table 29.11 shows that the maximum profitability is achieved when company spends $10 on acquisition and $60 on retention per customer. Using their ARPRO (Allocating Resources for Profits) model.10 about Here We can see from Table 29. The above tables clearly show that firms can maximize profitability by optimal allocation of resources between acquisition and retention.10 and 29. and Kumar show that a small deviation of even 5% away from the level of optimum spending (either above or below) can have significant consequences on the overall profitability of the firm.60/70) on retention. and Kumar (2004) shows that firms can maximize profitability by balancing acquisition and retention.e. 10/70) on acquisition and 86% (i.11.e. The recommended budget split between acquisition and retention in this case is 14% (i. Further research by Thomas.11 about Here Table 29. 34 . Reinartz. Thomas. they were able to determine the point at which extra spending on customer retention starts to reap diminishing returns. The results from their study using data from a pharmaceutical company are presented in Tables 29.Deighton (1996) show that optimizing the resources spent on marketing to maximize either the retention rate or the acquisition rate may not result in maximization of profits. Table 29. It is the balancing of acquisition and retention spending and acquiring the customers who are most likely to provide future profits that help to maximize long-term profitability and customer equity.
Table 29.Retention cost (High/Low) Vs Acquisition cost (High/Low).12. They compared the profits generated by customers in a mail-order company and the cost and effort required to acquire and retain them. Customers who are cheap to acquire but expensive to retain (High-maintenance customers) contributed only 15 % of the total profits. firms need to carefully pick customers from each of these four cells rather than going after only customers who are inexpensive to acquire or retain. Thomas. In 35 . This illustrates that profitable customers are present in all four cells . Largest profit contribution (40% of profits) came from the smallest group (15% of customers). Implementing CLV Framework in a B-to-C Organization Collection of transaction data for all the end consumers poses a great challenge for a B-to-C organization. Reinartz. The results are provided in Table 29. Thus.In order to balance acquisition and retention appropriately. Customers who were expensive to acquire and retain (Royal customers) contributed 25% of the total profits.12 shows that 32% of all customers were easy to acquire and retain (Casual customers) but they accounted for only 20% of the total profits. to maximize financial performance. The data collection can be very expensive because of relatively large number of customers. and Kumar (2004) have shown that firms need to realize that the acquisition or retention costs of profitable customers can be either low or high.12 about Here Table 29. This is true in the case of an FMCG manufacturer who sells through the intermediary channels. In some cases getting transaction data on all the customers is impossible because the firm is not in direct contact with the end-consumers. the customers who are expensive to acquire but cheap to retain (Low-maintenance customers).
The basis for allocation can be either the share value of purchase or the contribution. Case Study 1: CLV Framework Applied to Software Manufacturer A software manufacturer who sells through intermediaries has limited information about the transactions by the end consumers. The firm can therefore identify high potential customers who have matching profiles with existing high value customers and create marketing strategy to reach out to these 36 . and their demographic/firmographic variables. survey data gives us a measure of purchase frequency. Company can conduct a survey of a large number of end consumers (say 2000) and collect information on what products and upgrades have been bought by each customer in the past. This can be illustrated using following case studies. For example. the manufacturer cannot calculate the value of the end consumer using the data available with the company. the firm can calculate the value of each customer. Based on this information. This will help the firm to identify the profile of high value customers. Marketing cost in this case may not be available at an individual customer level. However the firm can allocate mass communication costs to individual customer level. Based on this information. the customers can be grouped into deciles or segments based on the customer value. the computation and application of CLV need to be modified to make maximum use of the framework. Once the customer values are calculated. Instead it can rely on survey data. types of products purchased and marketing costs.such cases. In this case. measure of purchase value and thereby a measure of the contribution margin. The firm can then profile the customers in different segments / deciles. This gives us information on transactions for consumers in the sample. contribution margin and market costs and assess the value of the customer. the firm can make projections on future frequencies.
Then select randomly a sample of customers within each group for all the age groups and collect information about the quantity of soft drink (specific brand) consumed by each respondent. 37 . This will ensure targeting and acquiring prospects who have high customer lifetime value which in turn will help to maximize the customer equity of the firm. Also the number of end-consumers will be unmanageably large. In order to identify the drivers. Instead. For example customers can first be grouped into 6 age groups. 30-39yrs. 13-18yrs. information can be collected by contacting the head of the household. and the demographic variables using a questionnaire survey. and >50yrs. Though the company may have the data on sales to its intermediaries. Case Study 2: CLV Framework Applied to Soft Drink Manufacturer A soft drink manufacturer usually sells through its intermediary channels. In the case of <13yrs age group. The age groups can be <13Yrs. The average consumption and the variation within each age segment may vary as given in Figure 29. it is unlikely to have transaction data for all the end consumers. 18-29yrs. 2005). Based on this data the firm can arrive at a rough estimate of the lifetime value of a customer in each age group. the firm will be interested in knowing the drivers of consumption at different age groups so that it can improve the drivers of CLV to maximize the customer value from that age group (Kumar & George. 40-50yrs.prospects. It is expected that the consumption pattern in one age segment may be quite different from that in another segment. The contribution from each customer may be low and hence managing business at an individual level may not be the right strategy because of high touch cost relative to the contribution from an individual customer. the firm needs to gather information on consumption and demographic variables from a large number of respondents from different age groups.2.
Education.…) These drivers of consumption pattern help the firm to predict the lifetime value of customers in that age group across a heterogeneous group of individuals. If a firm computes the average yearly consumption of a specific brand of soft drink for different age groups.2 about Here Figure 29. the variation in consumption within an age group may be high. For instance. Occupation.2 will help us to understand how the average yearly consumption varies across different age groups and the variation within each age group. Average lifetime consumption = 8*1000 + 8*1500 + ……+ 25*1600 = 123. the firm should identify the demographic variables which explain the variation in consumption pattern of customers within an age group either by regressing the average monthly consumption quantity on different demographic variables or by using other suitable statistical techniques.Figure 29. Therefore the average consumption will not help us in developing strategies for the age segments. Instead. Firms can then formulate suitable marketing strategy for each age group to maximize the customer value from each age group. Gender. If we assume a typical consumer starts consumption at the age of 5 and the average life expectancy is 75years. suppose that the consumption figures for each age group are as given in Figure 29. we can compute the total consumption by an average consumer as. It can make use of publicly available data such as census to collect 38 .000 oz However. Income. Ethnicity. it can calculate the total consumption of that brand of soft drink by an average consumer in his/her lifetime. Religion.2. The average monthly consumption quantity (CQ) can be expressed as a function of demographic variables as given below: CQi = f (Age.
total of lifetime values of all the customers in that segment). Each product or brand is 39 . CLV based approach calls for classification of customers as high and low value and differential treatment to customers based on their value to the firm. developing the right communication and marketing strategies. brand building. and brand equity. Organizational Challenges in Implementing a CLV-based Framework Firms can no doubt benefit from a CLV-based framework in terms of acquiring and retaining the profitable customers. However. Such information along with the drivers of lifetime value can be used to predict the lifetime value of customers in each group (i. firms followed a brand or product centric marketing approach. the emphasis is on new product development. Customer differentiation can potentially lead to consumer backlash unless the process is carefully managed by the firm (Diane. This will help the firm to direct its marketing efforts to the high value customer segment.e. When firms adopt brand or product management structure.information on demographic variables of customers in different age group as well as the growth in each age segment of the population. and allocating resources optimally so that the profits are maximized. 2000). Transformation from Product Centric to Customer Centric Marketing Traditionally. The important challenges faced while implementing a customer-centric approach are discussed in this section. These two strategies collectively will maximize the customer equity of the firm. the firms face many organizational challenges in implementing such a framework. It can also use the profile information of high value customer groups to target high potential prospects.
firms need to move from a product centric to customer centric approach. However. What should be the outcome of implementation of CLV framework 40 . and type of the marketing contacts. transformation from a product centric to customer centric marketing may not be always easy. Though the cost of data collection and storage has decreased over the years. the amount of purchase. integrating the data and making use of the available information. Challenges in Data Collection and Management Firms need to collect individual level data about all its customers on a large number of variables in order to compute CLV. Often the same customer is contacted by different groups with possibly different messages. It may also involve realignment of organizational roles and integration of different functions. the number. time. Firms have to consider customers as sources of value rather than only brands / products as sources of value. Some key informational needs are demographic/ firmographic information. For the successful implementation of CLV framework.managed by different brand managers and the marketing and sales activities planned by one group are independent of those by other product groups. Building customer equity rather than brand equity should be the central goal of resource allocation and strategic marketing expenditures. In customer centric approach. products purchased in each occasion. Before start collecting the information. many firms face challenges in identifying the right informational needs. Firms effectively managing this transition have laid down the foundation for implementing CLV based customer management. the customer is the focus and the organizational activities are centered on them. It requires concerted effort by the top management to change the organizational level philosophy of doing business. firms should ask the relevant questions.
Unless an organization is effectively using CLV to achieve these results and maximizing the profitability. 2002). But the firm should evaluate the benefits of gaining information about prospects vis-à-vis the disadvantage of loosing the private customer information. As discussed earlier.specific to the firm? In the context of your organization what are the possible drivers of CLV on which you need to collect information? Answers to these questions help the firms to manage the data more effectively.. 2002). How to Make the Most of the CLV Framework? Firms often get in to the trap of calculating CLV for its customers once and not using it to maximize the firm’s profitability (Bell et al. Organizations have to understand CLV as a dynamic measure which changes as a result of customer-specific marketing actions. They limit the use of CLV scores only to segment the customers but not to implement customer specific communication and marketing strategies which maximizes the customer equity of the firm. Another area in which firms face challenge is in gathering information about prospects and competitor’s customers. and reaching the right customers with right message through the most apt channels. One way to obtain this information is to cooperate with the competition like the catalog retailers and global airline industry (Bell et al.. CLV can be used to optimally allocate resources. Future of CLV 41 . it is not making the most of the CLV framework. This information is important for the acquisition process. predicting future purchase of customers.
42 . Firms. 2003) of changes in the amount and quality of marketing mix need to be developed. while gathering and using customer level information. (2) a better understanding of the antecedents or drivers of CLV. There is growing concern among customers about privacy of their information. considering the dynamic nature of the purchase behavior of customers more sophisticated models that incorporate the conditional effects (Reinartz & Kumar. should be aware of this and take steps to gain the confidence of customers. Improvements are expected in: (1) measuring CLV. many firms continue to use traditional metrics. However. and (3) emergence of the evidence regarding the importance of using CLV as the metric for Resource Allocation. Though recent studies have shown the impact of using CLV as better metric for resource allocation.CLV framework relies on customers’ personal and behavioral information. The future models are also expected to incorporate the impact of Word-ofMouth in determining the lifetime value of customers. With more and more firms adopting CLV framework for resource allocation and other customer specific strategies. One possible reason may be the inertia to move away from the accepted practices while another reason is the lack of empirical evidence supporting the impact of use of CLV on profitability. The formula for calculation of CLV has improved in the past two years significantly. CLV is expected to gain wide spread acceptability as the preferred metric for resource allocation. Identification of other meaningful antecedents of CLV in addition to the ones discussed in this chapter and understanding their relationships with lifetime value is another area where improvements are expected. CLV framework is also expected to undergo further sophistication and improvement.
Rajkumar and V. 68(4). Kumar (2004). 43 . Journal of Marketing. 2 All figures have been altered by a constant multiplier due to confidentiality reasons. A Customer Lifetime Value Framework for Customer Selection and Optimal Resource Allocation Strategy. 106-125. ENDNOTES 1 For details please refer “Venkatesan.ACKNOWLEDGMENT The author sincerely thanks the assistance of Morris George in the preparation of this chapter.
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6 1.5 Points for Recency : 20 if within past 2 months. 03 if within past 9 months.1b RFM Method (Frequency Score) Customer JOHN SMITH MAGS Purchases (Number) 1 2 3 1 1 2 3 4 Frequency 1 1 1 2 1 1 2 1 Assigned Points 3 3 3 6 3 3 6 3 Weighted Points 0. Maximum = 15 points. Relative weight = 50% Table 29.2 0.2 0.5 1.5 10 5 2.6 Points for Frequency: 3 points for each purchase within 12 months. 05 if within past 6 months.6 0.5 2. 01 if within past 12 months.1a RFM Method (Recency Score) Customer JOHN SMITH MAGS Purchases (Number) 1 2 3 1 1 2 3 4 Recency (Number) 2 4 9 6 2 4 6 9 Assigned Points 20 10 3 5 20 10 5 3 Weighted Points 10 5 1.6 0.Table 29. 10 if within past 4 months.6 0. Relative weight = 20% Table 29.6 1.1c RFM Method (Monetary Value Score) 47 .
1b.4 * Recency.Kumar. New York Table 29.0 Monetary value score* 6.7 2. frequency.2 Monetary Value: 10 percent of the $ Volume of Purchase with 12 months..1a.5 19.4 1.9 11.5 2.6 1.1 2. Relative weight = 30% Source: (for Tables 29.2 30. and monetary value scores are sum of weighted points for Recency.4 RFM score 24.1d RFM Score Customer JOHN SMITH MAGS Recency score* 16.0 Frequency score* 1. John Wiley & Sons. V.8 1.8 7. and monetary value for each customer.5 2.2 3. George S. Maximum = 25 points. frequency.5 8.2 3.6 7.Aaker.2 Spending Pattern of a Customer (for Calculation of PCV) Purchase Amount ($) GC January 800 240 February 50 15 March 50 15 April 30 9 May 20 6 Table 29.3 Spending Pattern of a Customer (to Calculate NPV of EGC) January February March April May 48 . and 29.1c) Marketing Research”. Table 29. Inc. David A. Eighth edition. Day (2003).Customer JOHN SMITH MAGS Purchases (Number) 1 2 3 1 1 2 3 4 Monetary $40 $120 $60 $400 $90 $70 $80 $40 Assigned Points 4 12 6 25 9 7 8 4 Weighted Points 1. 29.
” Journal of Marketing.Purchase Amount ($) Gross Margin 800 240 50 15 Figure 29. Girish Ramani. 60-72. “The Impact of Customer Relationship Characteristics on Profitable Lifetime Duration. V. Customer Lifetime Value Approaches and Best Practice Applications. Table 29. and Timothy Bohling (2004). 77-99 49 ..4 Drivers of Profitable Lifetime Drivers Spending Level Description Impact on Profitable lifetime (+) (+) (-) (∩) (+) (+) (+) (-) Average monthly spending level over a given period Cross-buying Number of different product/categories purchased Focused buying Purchase within one category Average Number of days between purchases Interpurchase Time (average) Loyalty instrument Customer’s ownership of company’s loyalty instrument (B-to-C) or availability of line of credit (B-to-B) Mailing Effort by the Number of mailing efforts of the company company(B-to-C) or the number of contacts (B-to-B) Income Income of the customer (B-to-C) or income of the firm (B-to-B) Population density Number of people in a two-digit zip code (only B-to-C) Source: Reinartz and Kumar (2003). 18(3). Journal of Interactive Marketing.1 50 15 30 9 20 6 Variation in Inter Purchase Time Customer 1 Customer 2 Observation period Month 1 Month 8 Month 12 Source: Kumar. 67(1).
380 216.785 72.908 979 70.929 27. 67(1).588 143.855 60. Journal of Marketing.6 Comparisons of CRM Metrics for Customer Selection Percentage of Cohort (Selected from Top) 5% Gross profit ($) Variable costs ($) Net profit($) 10% Gross profit ($) CLV 144.910 44.837 50 .305 Advanced RFM Past Customer Value (PCV) 179. Werner J.401 PCR 71.831 62.781 27.839 * Cohort 1 had 4202 observations.981 PCV 131. 77-99.582 186. Table 29. Notes: Results were similar for cohort 2 (4965 observations).125 61.991 361. and V.686 CLD 107.5 Actual Revenues and Profits for the Selected Group of Customers Based on NPV of ECM (CLV).729 225. The Impact of Customer Relationship Characteristics on Profitable Lifetime Duration.738 140.295 78.883 1.389 55.916 210. and cohort 3 (n=2825) Source: Adapted from Reinartz.719 790 106. and Past Customer Value Selection (Cohort 1*) Percentage of Cohort (Selected from Top) 30% (n=1260) Revenue Profit 50% (n=2101) Revenue Profit 70% (n=2941) Revenue Profit NPV of ECM (CLV method) 318..Table 29.860 41.798 42. RFM. Kumar (2003).735 950 130.665 35.267 36.636 380.
The reported values are cell medians.892 52.782 610 55.227 44.7 Segmentation of Customers Based on Customer Lifetime Profits and Relationship Duration BUTTERFLIES • Good fit between company’s offerings and customers’ needs • High Profit potential • Action o Aim for transactional satisfaction. 51 . A customer Lifetime Value Framework for Customer Selection and Resource Allocation Strategy.225 Notes: All metrics are evaluated at 30 months. July. impose strict cost controls High High Customer Lifetime Profits Low Low Relationship Duration Source: Reinartz.”The Mismanagement of Customer Loyalty.” Harvard Business Review.147 807 55.Variable costs ($) Net profit($) 15% Gross profit ($) Variable costs ($) Net profit($) 1.245 77. not attitudinal loyalty o Maximize profits from these accounts as long as they are active o Stop investing once inflection point is reached STRANGERS • Little fit between company’s offerings and customers’ needs • Lowest profit potential • Action ο Make no investment in these relationships ο Make profit on every transaction TRUE FRIENDS • Excellent fit between company’s offerings and customers’ needs • Highest profit potential • Action ο Consistent intermittently spaced communication ο Achieve attitudinal and behavioral loyalty ο Invest to nurture/defend/retain BARNACLES • Limited fit between company’s offerings and customers’ needs • Low profit potential • Action: ο Measure size and share of wallet ο If share-of-wallet is low. with an 18-month prediction window.963 738 44. Rajkumar.591 809 51. Werner and V Kumar (2002). 106-125.340 943 27. Table 29.170 794 71.114 944 14. Kumar (2004). Source: Venkatesan. 68(4). and V. focus on specific up and cross selling ο If size of wallet is small. 1-13.156 56. Gross profit for the firm which provided the database is approximately 30% of the revenue. Journal of Marketing.038 15.
Base level is in parentheses. “A Purchase Sequence Analysis Framework for Targeting Products. Source: Kumar.580) 1 (18) 637 (6.130) -750 (3.625) -4 (15) 3..610) 75 (4.10 Average Customer Relationship Duration (as a Function of Retention Spending) 52 .9 Change Between Current Year and Previous Year Revenue ($) Cost of Communication ($) # of attempts before purchase Profits ($) Return on Investment (%) Test Group 1050 (18.2 (2) * The reported values are unit values per customer Number indicates change from base level (previous year).Table 29.7) Control Group 1033 (17. forthcoming. Customers and Time Period’. Rajkumar Venkatesan and Werner Reinartz (2005).8 Segmentation of Customers Based on Past and Future Profitability RISING STARS Action ο Invest to deepen relationship ο Identify specific up-sell/ cross-sell opportunities ο Cultivate attitudinal loyalty TRUE LOYALISTS Action ο Cultivate attitudinal loyalty ο Invest to nurture/defend/retain ο Reward proactively High Future Profitability (CLV) TOTAL MISFITS Action ο No relationship investment ο Aim to extract profit from every transaction by migrating the customer to low cost channels FALLING ANGELS Action ο Identify specific up-sell/ crosssell opportunities ο Transact through low-cost channels ο Optimize (Minimize) Marketing costs High Low Low Historical Profits (PCV) Table 29. V.000 (9080) 504 (3.275) 2. Journal of Marketing Table 29.
437 $1.423 $1.443 $1.557 $1.557 $1.11 Average Customer Profitability (as a Function of Acquisition and Retention Spending) Retention Spending $40 $1 $5 Acquisition $10 spending $15 $20 $1.543 $1.597 $1.563 $1. Harvard Business Review.437 $1.418 Source: (for Table 29.. 116-123.583 $1.418 $50 $1.597 $1.Retention spending (per customer) Estimated relationship duration (days) $40 122 $50 135 $60 142 $70 143 $80 138 Table 29.423 $1.563 $1.538 $60 $1.557 $1.437 $1.603 $1.11) Thomas. Jacquelyn S.557 $1. Werner Reinartz.10 & 19.437 $1. and V. Getting the Most out of All Your Customers.543 $1. 53 .578 $70 $1. Kumar (2004). July-August.443 $1.538 $80 $1.
54 . Getting the Most out of All Your Customers. July-August.Table 29. Kumar (2004).12: Customer Segments Based on Acquisition and Retention Costs High-maintenance customers High 25% of customers 15% of profits Royal customers 28% of customers 25% of profits Retention cost Casual customers 32 % of customers 20% of profits Low-maintenance customers 15% of customers 40% of profits Low Low Acquisition cost High Source: Thomas. Jacquelyn S. Harvard Business Review. and V. 116-123. Werner Reinartz..
Figure 29. 55 .2 Soft Drink Consumption Pattern Across Age Groups Age <13Yrs 13 – 20 Years µ1 = 1000 oz 21 – 30 Years µ2 = 1500 oz 31 – 40 Years Variation in consumption pattern µ3 = 2000 oz 41 – 50 Years Frequency > 50 Years µ4 = 2500 oz µ5 = 1800 oz Average Yearly Consumption (oz) µ6 = 1600 oz Note: The average yearly consumption figures are for illustration purpose only.
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