Customer Lifetime Value
Prof Shelendra K. Tyagi
Customer Lifetime Value
• In October 2009, Groupon offered its first deal. For $ 13
(one half the normal price of $ 26) a customer could
purchase two pizzas from the Chicago Motel Bar pub.
Groupon took one half of the $ 13 and gave Motel Bar
one half of the $ 13. On average the variable cost of a
pizza is approx. 35 % of the pizza’s retail price. Motel Bar
received $ 6.50 for pizza that had a variable cost of
$ 9.10. At first glance it seems that Motel Bar would lose
$ 2.6 for each customer who took the Groupon deal;
however, Motel Bar understood that the Groupon deal
might bring in new customers who would earn Motel Bar
a significant future profit that would more than make up
for the $2.6 on the customer’s first pizza purchase. If the
merchants using Groupon did not understand the
importance of the long-term value generated by the
customer, then Groupon would have never existed.
Customer Lifetime Value
• How to Estimate CLV?
– Cohort and Incubate
• Set aside a bunch of new customers. Keep track of their
subsequent Cash Flows. PV the cash flows for the cohort
back to acquisition date; divide by the number of
customers.
– Just Spreadsheet it.
• Crutchfield (repurchase rates depend on recency)
– A SIMPLE FORMULA
The Simplest CLV Model
• The firm receives Rs M in net cash flow each period the
customer is retained.
• Rs M is revenue minus costs minus any retention
marketing spending.
• The customer is retained with probability (or rate) r each
period.
• The customer churns with probability 1- r.
• The per-period discount rate is d.
CLV of an existing customer who was just
retained.
r*RsM r2*RsM r3*RsM r4*RsM
• CLV = -------------- + --------------- + -------------- + --------------
(1+d) (1+d)2 (1+d)3 (1+d)4
Rs M * r
CLV = -------------
(1+d-r)
CLV of an existing customer who was just
retained.
r*RsM r2*RsM r3*RsM r4*RsM
• CLV = -------------- + --------------- + -------------- + --------------
(1+d) (1+d)2 (1+d)3 (1+d)4
Rs M * r
CLV = ------------- if r = 0,
(1+d-r)
CLV=0
CLV of an existing customer who was just
retained.
r*RsM r2*RsM r3*RsM r4*RsM
• CLV = -------------- + --------------- + -------------- + --------------
(1+d) (1+d)2 (1+d)3 (1+d)4
Rs M * r
CLV = ------------- if r = 1,
(1+d-r)
CLV=RsM/d
CLV of a new customer (if and when
we acquire her).
r*RsM r2*RsM r3*RsM r4*RsM
• CLV= RsM + -------------- + --------------- + -------------- + -------------
(1+d) (1+d)2 (1+d)3 (1+d)4
Rs M * (1+d)
CLV = ---------------- if r = 0
(1+d-r)
CLV = RsM
CLV
• An ISP charges $19.95 per month. Variable costs are
$1.50 per account per month. With marketing
spending of $6 per year, attrition is only .5% per
month. At a monthly discount rate of 1%, what is
CLV?
CLV
• $M = $19.95 -$1.5 -$6/12 = $17.95
• r = 0.995
• d = 0.01
• CLV of existing customer = $M x r/(1+d-r) = $1,191
• CLV of a new customer = $M(1+d)/(1+d-r) = $1,209
CLV: Varying Margins
• Customer margins tend to increase with the length of a
customer’s tenure.
• To handle growing customer margins, values are needed for the
following three parameters:
o Year 1 Margin per customer – this is the margin at the beginning of year 1, say, $ 1 in this case
o Steady state margin per customer – This is the per period profit margin for a customer who is with
the company for a longer period of time. Assume the steady state margin increases from $ 1 to $
1.50.
o Periods – until margin per customer is halfway to the steady state margin ($1.25). Call this T*. Now
assume that T* = 3 periods
• We can compute the margin for year n as follows:
Year n margin = Year 1 Margin + (Steady state margin – Year 1 Margin)*(1- e-kn )
• Here k = -LN(0.5)/T*. Thus for T* = 3, k=0.231
