Customer Lifetime Value

Prof. A. K.
Biswas
Management Tools
The essence of business is the acquisition, retention, and enhancement of business from customers at a profit to the company. There are few key issues here: Which customers we should acquire? How do we acquire the desired customers?
Prof. A. K. Biswas
Management Tools
Which customers we should retain and grow our business with? How can we retain the desired customers? How do we enhance the business with these customers at a profit to our business? What management tools can help us to take decisions on these issues?
Prof. A. K. Biswas
Prof. A. K. Biswas
Agenda

What Is Customer Relationship Management? Why Customer Relationship Management? Are All Loyal Customers Profitable? With Which Customers To Build Relationship? How To Grow Business With Profitable Customers? #
Prof. A. K. Biswas 5
Agenda
How To Retain Profitable Customers? How to Measure the Impact of CRM Strategy? How To Measure Customer Lifetime Value? How to Measure Net Promoter Score?
Prof. A. K. Biswas
What is Customer Relationship Management?
Customer relationship management is the strategic use of information, processes, technology, and people to manage the customers relationship with your company across the whole customer life cycle. Customer life cycle is the total time that the customer is engaged with your company from the customers experience and viewpoint.
Why Customer Relationship Management?

Business is all about getting, keeping, and growing business with customers. In a competitive market, customers are difficult to find and hard to keep. To remain competitive, the company must figure out how to keep the customers longer, grow them into bigger customers, make them more profitable and serve them more efficiently.
Customers, therefore, should be thought of as assets, and expenditures directly relating to acquiring and maintaining them should be treated accordingly. There are two sides of customer value the value a firm provides to the customer and the value of a customer to the firm.
The value of a customer to a business firm over the life time of its relationship with the firm is the present value of all current and future profits generated from the customer over its life of business with the firm. It is called Customer Life Time Value (CLV). The longer a customer stays with the firm, it generates more profit to the firm.
Customer loyalty is generally measured by the retention rate - the percentage of customers buying this year who also buy next year. For most companies, customer loyalty is the single most important determinant of long term growth and profit margins.

Growth of Total Number of Customers over 10 year Period
Growth of new accounts Retention (%) 95 90 85 80 0% (Mature) -37 -61 -77 -87
Prof. A. K. Biswas
10% 20% (Moderate) (High) 55 0 -37 -67 252 136 55 0

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It is argued that there are four sources making loyal customers more profitable. Profit from reduced operating costs. Profit from price premium. Profit derived from increased purchases. Profit from referrals to other customers.
The customer lifetime value (CLV) is the net present value of a customer that is, the discounted value of the net cash flow (profit) generated over the life of the relationship with the company. The cash flow is usually low or even negative at the beginning and then grows strongly over the years as a result of the factors described earlier.

How much a 5% increase in loyalty lifts CLV
95 85 85 84 81 75
Car insurance
Car Service
35 Software
Banking
Prof. A. K. Biswas
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Value with 90 per cent retention
Customers Average CLV Business Value
(with 10% growth of new accounts)
100,000 Rs.10,000 Rs.100 crore
Value with 95 percent retention

Customers Average CLV Business Value
(with 10% growth of new accounts)
155,000 Rs.18,500 Rs.287 crore

16
Prof. A. K. Biswas
Are All Loyal Customers Profitable?
However, there are no strong evidence that the loyal customers are always most profitable. Certain empirical evidences suggest that long-standing customers are not consistently cheaper to manage than short term customers. Within any one company, monthly cost of maintaining relationship with an individual customer vary enormously.
At the very least, the link between loyalty and lower costs is industry specific. No doubt there are industries in which the older customers are the cheapest to serve, but there are also others in which they are more expensive to satisfy.
Prof. A. K. Biswas
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Certain evidences from the corporate service provider show that long term customers consistently paid lower prices than the new customers did between 5% to 7% lower, depending on the product category. There is also no evidence that loyal customers paid higher prices in the consumer businesses as well. Indeed, like corporate clients, consumers also expect, and get, some tangible benefits for their loyalty.
Empirical evidences do not also show any strong link between customer longevity and the propensity to market the company by word-of-mouth. Empirical evidences do, however, suggest customers who scores high on both on attitudinal and actual loyalty are more likely to be active word-of-mouth marketers.
Prof. A. K. Biswas
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With Which Customers to Build Relationship?
If all loyal customers are not necessarily profitable, or at least, not equally profitable, then with which customers to we should build relationships? Since all customers are not equally profitable, investment in customers should vary by their profit potential. A firm provides value to the customer in terms of products and services, and a customer provides value to a firm in terms of stream of profits over time.

Value of Customers
High Vulnerable Customers Star Customers
Low
Lost Causes
Low
Free Riders
High
Value to Customers
Vulnerable Customers provide high value to the firm but do not get lot of value from the companys products and services. These may include newly acquired customers or long-standing customers who, largely through inertia, remain loyal.
In a sense, these customers are being exploited by the company. These customers are vulnerable and prone to defect to the competitors unless corrective action is taken. A company can invest in these customers through better product offerings, additional services, and related activities.
Free Riders get a superior value from using the companys products and services but are not very valuable to the firm. For whatever reason (large size, competition), these customers are exploiting the relationship with the company, appropriating the lions share of value.
In general, a firm should either reduce its service level or raise prices for the Free Riders. Although there would be risk in loosing these customers, it would, if successful, enhance their value to the firm.
Lost causes are a group of customers who gets low value from the company company and these customers are not valuable for the company either. It is not worth building relationships with such customers. Star customers, on the other hand, receive high value from the company and in turn, contributes high value to the company. These customers are more stable in their relationship with the company and therefore need to be retained and grow business with. Prof. A. K. Biswas 27
True Friends Good fit between company's offerings and customers' needs. Highest profit potential. Actions Communicate consistently but not too often. Build both attitudinal and behavioral loyalty. Delight these customers to nurture, defend, and retain them Barnacles Strangers Limited fit between company's Little fit between company's offerings and customers' needs. offerings and customers' needs. Low profit potential Low Lowest profit potential Actions Profitability Actions Measure both the size and share Make no investment in these of wallet. relationships If share of wallet is low, focus on Make profit on every transaction up-and cross-selling. If size of wallet is small, impose strict cost controls. Short Term Customers Long Term Customers 28 Prof. A. K. Biswas Butterflies Good fit between company's offerings and customers' needs High profit potential Actions High Aim to achieve transactional Profitability satisfaction, not attitudinal loyalty. Milk the accounts only as long as they are active.
Every companys customers can be divided in three categories: Promoters are loyal enthusiasts who keep buying from a company and urge their friends to do the same. Passives are satisfied but unenthusiastic customers who can be easily wooed by the competition. Detractors are unhappy customers trapped in a bad relationship.
Customers can be categorized according to their answer to the ultimate question: How likely is it that you would recommend this company to a friend or a colleague? Those who answer nine or ten on a zero-to-ten scale are promoters.

Those who score seven or eight are passive. Those who answer six to zero are detractors. A company should continuously make effort to increase the percentage of promoters by building effective and mutually beneficial relationships with such customers and simultaneously reducing the percentage of detractors.
Customer profitability is primarily driven by three components:
Customer acquisition (acquisition rate and cost); Customer margin (profit margin and growth); and Customer retention (retention rate and cost).
The company should acquire customers who desire its value proposition and so fit its core capabilities. A company should acquire a customer only if the value of the customer to the company over his/her entire life with the company is more than the acquisition cost. A customer acquisition strategy must also take into account the differences in customers lifetime value.
Customers value depends not only on how much they spend on a single occasion but also their purchase frequency and longevity. Bank and credit card companies have realized this for many years, offering credit cards to students who have limited current but significant future value.
In business markets, a firm must look for customers who are expected to grow differentially faster than the industry, either because they are in fast growth market segments or because they have strong competitive advantages (share determining customers). They may cost a lot to acquire, but they deliver higher returns than many other customers because of the duration and extent of their influence.

A company may also target competitors customers who have low acquisition costs: the genuine switchable customers. In fact, a company should target customers based on the life cycle of the product/market.

Customer Type
HighShareSwitch Your Competitors Profit Determining able Loyal Loyal Entry Growth Maturity Decline

A company may also like to acquire a customer if it is an opinion leader/leading edge customer who can open the door to other customers who are influenced by them. Finally, it makes sense to have a portfolio of customers that takes into account not only their expected lifetime value but also the risk or uncertainty associated with it.
How to Grow Business With Profitable Customers?
While customer acquisition focuses on growing the number of customers, increasing customer margin focuses on growing the profit from each customer. Growth can be achieved by a variety of methods such as: Up-selling (e.g., migrating customers to a higher price/profit product) and Cross-selling related products (e.g., providing a credit card to a bank customer).
A company which wants to grow profits from its customers, must know not just the amount of money customers spend with the company, but also the share of wallet the company has. Disney is a company that successfully increased its customers share of wallet.
During the mid-1980s, Disney found that a typical family of four people who visited the theme park in Orlando, Florida, spent several thousand dollars for their trip which included cost of airfare, the hotel stay, and the entrance fee to the Disneys theme park. However, Disney found that it captured only a relatively small fraction of the total money spent by a family.
In its effort to increase its share of the customers wallet, Disney decided to build hotels on Disney property, offer a choice of multiple Disney restaurants, and even have a Disney cruise ship. This investment has led to a substantial increase in Disneys share of wallet of a typically Disney visitor.
Careful examination of share of wallet requires strategic thinking about how you define your market (or wallet) and your competition. The share of wallet should not be too broad (i.e., total spending), not too narrow (i.e., just your revenues), but just right.

It often takes considerable effort to acquire a customer. Once you establish a relationship with a customer, it makes sense to maximize the value of the relationship by selling customers multiple products. In many cases, there is a natural progression of the products.
For example, bank customers typically start with a savings account and then gradually move to loans and investment advice. Cross-selling also has the potential to improve customer satisfaction and retention.
Having invested in a customer, it also seems logical to prolong this relationship by providing products and services that meet the changing needs of that customer over time. In case of automobile manufacturers, financing has become a very profitable part of the business.
However, when products and services seem to have little synergy in production or image match, customers are skeptical of such joint offering. Moreover, even seemingly related products may require different skills to produce and deliver. Moreover, a varied product line may divide companys attention so that business may suffer.
How to Retain Profitable Customers?
In their zeal to grow, many companies focus almost exclusively on entering into new markets, introducing new products, and acquiring new customers. However, often as they add new customers, old ones defect from the firm. Some studies report that average retention rate for U.S. companies is about 80%.
Studies also show that the cost of acquisition is generally much higher than the cost of retaining existing customers. It is, therefore, obvious that a firm should focus on retaining its existing customers. Unfortunately, in general, the cost of retention increases dramatically as the company reaches high retention levels.

Not all customers have the same attraction to the company. Some may receive high value from the firm, while others may find the benefits marginal. While the first group can be retained relatively easily, retaining the second group is typically expensive. Therefore, there is an optimal level of retention that a company should strive for.

At the core of customer retention strategy lies a simple commitment to deliver results. Not satisfaction, not delight, but the best possible solution to an individual customer's needs. Each customers needs are unique and present an opportunity to deliver an unique solution.

Learn these needs well, and promise your customer an unique solution. Deliver the results promised. Flex your commercial imagination and search ambitiously for everbetter solutions to your customers needs. Probe their markets and their operations, their habits and their hopes.

Innovate constantly for delivering best value to the customers at the lowest cost possible. Trust of the customer grows as you deliver results, dependably, time after time. Cultivating those relationships takes agility and flexibility, with a culture, systems, measurements, and economics to match.

Engage the customers in an active dialogue and involve them in creating the value for them. The competence that customers bring is a function of the knowledge and skills they possess, their willingness to learn and experiment.
Prof. A. K. Biswas
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More than 650,000 customers tested a beta version of Microsofts Windows 2000 and shared with the software giant their ideas of changing some of the products features.
Prof. A. K. Biswas
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CISCO gives its customers open access to its information, resources, and systems through an on-line service that enables Ciscos customers to engage in a dialogue. In this way, Ciscos customers solves the problems encountered by other customers, and each customer has access to Ciscos knowledge base and user community.

Michael Dell, Chairman and CEO of Dell Computer, in his book Direct from Dell says: You need to involve your customers intimately in the process to create a great customer experience.
Prof. A. K. Biswas
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We take our customers pulse regularly through more than 300,000 telephone, online, and face to face interactions every week and we are constantly humbled by the experience. Theyve taught us things that have directly affected our success; theyve kept us on course and prevented us from doing things that would have been disastrous.
When you and your customers are involved together in creation of value, you can shape the customers value criteria. Successful companies often are often as effective at influencing the purchase decision as they are at delivering superior customer value.
Incumbent companies have a major advantage in shaping their value criteria as they have more information about their customers than any competitor would have. Oracle, the software giant, after initially winning the customer, attacks applications and integration services as soon as its sales team has gathered up enough information about the customer requirements of these services. Oracle, thus, has built an enviable record of base retention.
As you give customized solution to the customer effectively you are increasing the switching costs of customers. For your customer to enjoy the value proposition of a new supplier, it must incur the cost, aggravation, and inconvenience of switching. If you have done a diligent job of entangling that customer, those switching costs could be a formidable barrier.
If you can entice customers into complex relationships to create enough immediate economic value for them, they may be reluctant to go through the hassle of undoing these relationships. GEs initiative At the Customer, for the Customer, was intended to make every GE division a kind of consultant for its customers, providing free help and advice to improve their operations and entangle them with their benevolent supplier.
CUSTOMER PROFITABILITY
As an organization translates a business model into action, it must execute effectively at the level of the individual customer where profit is ultimately created. A company must therefore invest in developing a detailed understanding of how profit happens at this level.
CUSTOMER PROFITABILITY
Customer profitability analysis helps the firm to focus on the handful of profitable accounts and make the others profitable or replace them by more profitable customers. An understanding of customer profitability allows an organization to rationalize investment, to focus on skills and activities that are most important to customers.`
PROTECTING PROFITABILITY
While a company is developing a powerful business model to generate profit growth, it must simultaneously search for and develop the strategic control points in its industry. The purpose of a strategic control point is to protect the profit stream that the business model has created against the corrosive effects of competition and customer power.
PROTECTING PROFITABILITY
There are many types of strategic control points:

Brand Patent Two year product development lead Twenty percent cost advantage Control of distribution Control of supply Value chain control
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STRATEGIC CONTROL POINT INDEX

Profit Protecting Power High High High Strategic Control Point Own the Standard Manage the Value Chain Own the Customer Relationship
Prof. A. K. Biswas
Example
Microsoft, Oracle Intel GE
67

Profit Protecting Power Medium Strategic Control Point Brand, Patent Example
Countless
Medium
Two-year Product Development Lead

Prof. A. K. Biswas
Intel
68

Profit Protecting Power Low Strategic Control Point One Year Product Development Lead Commodity with 10 to 20% Cost Advantage
Prof. A. K. Biswas
Example
Countless
Low
Nucor, SW Air
69

The value of a customer is a mindset. Its implementation requires a cultural change in the organization and needs to be supported by appropriate changes in the organizational structure and incentive systems.
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The organizational culture and climate must effectively encourage the following behaviours: Employees constantly try to see things from the customers perspective, putting themselves in the customers shoes. A set of beliefs that puts the customers interest first.
The ability of the organization to generate, disseminate, and use superior information about customers. Every decision is evaluated in terms of the return it generates from the customer. The coordinated application of interfunctional resources to the creation and delivery of superior customer value.
In a product based organization, each product manager tries to maximize his or her own products profitability. This structure does not facilitate the transfer of relevant customer information across products. However, a customer based organization provides a complete picture of a customer across products.
A product based organization is suboptimal because:
Individual product manager does not know the potential of that customer for another product of the firm and thus looses cross-selling opportunities. It can create inherent conflicts among product managers and departments.
A new organizational structure must also be supported by an appropriate incentive system to reward employees. Firstly, each manager should be rewarded on the basis of profitability of each customer and not on the profitability of individual product/brand. Secondly, the incentive system should recognize and reward the key elements that drive customer profitability.
As a firm moves from a product to a customer based organization, it requires a very different skill set for the employees. While a product orientation requires an employee to be an expert in his product only, a customer orientation requires that employees know about multiple products and understand customer needs more than product characteristics.
A second aspect of employee training relates to the training of frontline employees. As these employees come in contact with the customers, how they behave and interact with customers has a significant impact on customer satisfaction and retention.
A focus on customer profitability requires firm to move to customerbased costing, where costs are allocated to individual customers. Without such cost allocation, it is difficult to assess the profitability of each customer and hence design effective customer strategies.
How to Measure the Impact of CRM Strategy?
There are two methods to measure the impact of Customer Relationship Management Strategy of a company:
Customer long-term profitability or Customer Lifetime Value of all the customers of the company. Net Promoter Score of the company.
How to Measure the Customer Lifetime Value?
The fundamental metric in customer-oriented strategy is a customers long-term profitability or customer life time value. Drivers of customer life time value, such as acquisition cost, margin, and customer retention should also be monitored on a regular basis.
There is a simple approach to measure the lifetime value of a customer that is transparent to both company executives and investors, does not require large amount of data, is easy to understand and use for decision-making purpose. To arrive at this simplification, we need to make three assumptions:
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Profit margins remain constant over the life of a customer. Retention rate for customers remain constant over time. Customer lifetime value is estimated over an infinite horizon. There is ample justification for the same.
One study cautioned that there are significant costs associated with keeping customers for a longer lifetime through reward programs. Another study found that there is little or no evidence to suggest that customers who purchase steadily from a company are necessarily cheaper to serve, less price sensitive or particularly effective in bringing in new business.
Many studies have shown that models with constant retention rates for a customer or customer segment that allows for differences across customers are consistent with most data. It is also not necessary to arbitrarily the duration of a customer lifecycle, since the retention rate automatically accounts for the fact that over time the chances of a customer staying with a firm go down significantly.

Using the three simple, but reasonable assumptions, the Customer Lifetime Value may be estimated simply as under: CLV = m{r/(1+i-r)} where m = margin or profit from a customer per period (e.g., per year) r = retention rate (e.g., 80%) i = discount rate (e.g., 12%)

CLV is thus equal to the margin (m) multiplied by a factor r/(1 + i - r). This factor is called the margin multiple. This multiple depends on customer retention rate (r) and the companys discount rate (i). This discount rate is a function of the companys cost of capital and depends on the riskiness of its business and its debtequity structure.

Some typical margin multiple provided in the table below:
Retention Rate
10% 12%
is
Discount Rate
14% 16%
60%
70% 80% 90%
1.20
1.75 2.67 4.50
1.15
1.67 2.50 4.09
Prof. A. K. Biswas
1.11
1.59 2.35 3.75
1.07
1.52 2.22 3.46
87
The table provides a quick and easy way to estimate the lifetime value of a customer. For example, consider a company with discount rate of 12%, retention rate of 90%, and the annual margin for one of its customer is $100. The lifetime value of this customer is $100*4.09 = $409

The table also shows the value of retention. For example, at a 12% discount rate and 80% retention, the margin multiple is 2.5 instead of 4.09. Put differently, the lifetime value of a customer with $100 margin increases from $250 to $409 if the retention rate can be increased from 80% to 90%. This difference in customer value provides us with an idea of the maximum amount of money a firm should be willing to invest to improve customer retention.
If we add together all the life time values of a firms current and future customers, the result is customer equity. Customer Equity is the net value (profit), discounted back to the present, of all the future cash flows a firm expects its customers to generate.
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Customer equity management is a new approach to marketing and corporate strategy that finally puts customers, and more important, strategies designed to grow the value of each customer, at the heart of the organization.
Prof. A. K. Biswas
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How to Measure the Net Promoter Score?
Besides customer lifetime value (and customer equity), another still simpler way to assess the impact of a companys CRM strategy is to measure the Net Promoter Score of the company. Net Promoter Score (NPS)of a company is the percentage of promoters minus the percentage of detractors in its customer base. It provides the easiest-to-understand measure of how a company is performing.
Tracking net promoters offers organizations a powerful way to measure and manage customer loyalty. Firms with the highest net promoter scores consistently garner the lions share of industry growth. Those companies with most efficient growth engines companies such as Amazon. com, eBay, Dell operate at NPS efficiency ratings of about 50 to 80 percent.

So even they have room for improvement. But the average sputters along at an NPS efficiency of only 5 to 10 percent. Many firms have negative NPS, which means that they are creating more detractors than promoters day in and day out. These abysmal scores explain why so many companies cant deliver profitable sustainable growth, no matter how aggressively they spend to acquire new business.
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For a measure to be practical, operational, and reliable that is to determine the percentage of net promoters among customers and allow managers to act on it the process and results need to be owned and accepted by all of the business functions. And all the people in the organization must know which customers they are responsible for.
Overseeing such a process is a more appropriate task for the General manager of the business unit, than for the marketing department. The path to sustainable, profitable growth begins with creating more promoters and few detractors and making the net-promoter number transparent throughout the organization. This number is the number you need to grow. It is that simple and that profound.
The Manifesto For Blowing The Doors Off Business-as-Usual

You are a product of your decisions, not your conditions. Choose to be a player. Choose to be accountable. Choose service over self-interest. Choose to focus forward. Choose to play to your genius. Choose to get it done. Choose to risk more and gain more. Prof. A. K. Biswas 97 #
Prof. A. K. Biswas
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Customer Lifetime Value

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Prof. A. K.

What is Customer Relationship Management?

Why Customer Relationship Management?

Why Customer Relationship Management?

Why Customer Relationship Management?

Why Customer Relationship Management?

Why Customer Relationship Management?

10% 20% (Moderate) (High) 55 0 -37 -67 252 136 55 0

Why Customer Relationship Management?

Why Customer Relationship Management?

Why Customer Relationship Management?

Why Customer Relationship Management?

(with 10% growth of new accounts)

100,000 Rs.10,000 Rs.100 crore

Value with 95 percent retention

(with 10% growth of new accounts)

155,000 Rs.18,500 Rs.287 crore

Are All Loyal Customers Profitable?

Are All Loyal Customers Profitable?

Are All Loyal Customers Profitable?

Are All Loyal Customers Profitable?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

Customer profitability is primarily driven by three components:

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

With Which Customers to Build Relationship?

How to Grow Business With Profitable Customers?

How to Grow Business With Profitable Customers?

How to Grow Business With Profitable Customers?

How to Grow Business With Profitable Customers?

How to Grow Business With Profitable Customers?

How to Grow Business With Profitable Customers?

How to Grow Business With Profitable Customers?

How to Grow Business With Profitable Customers?

How to Grow Business With Profitable Customers?

How to Retain Profitable Customers?

How to Retain Profitable Customers?

How to Retain Profitable Customers?

How to Retain Profitable Customers?

How to Retain Profitable Customers?

How to Retain Profitable Customers?

How to Retain Profitable Customers?

How to Retain Profitable Customers?

How to Retain Profitable Customers?

How to Retain Profitable Customers?

How to Retain Profitable Customers?

How to Retain Profitable Customers?

How to Retain Profitable Customers?