Week 10: Profitability and Pricing 1 - Customer Profitability
Customer level metrics
RFM
2. Frequency: how often does a customer visit a store?
- Monetary value: how much does a customer spend in the store?
- Recency: length of time since a customer last purchased
Customer profitability: the revenues earned from and the costs associated with the customer relationship during a specified period
example: page 7
diagram: page 8
pyramid (3 levels)
Customer Lifetime Value (CLV)
PV of projected future cashflows attributed to customer relationship
customer profit: summarizes the past financial performance of a customer relationship
Retention and Attrition rate
Retention rate = Number of customers retained/ Number of customers at start
Attrition rate = 1 - Retention rate
Attrition rate: probability that a customer will leave the firm
Expected customer lifetime = 1/ Attrition rate
Discount rate (similar to finance)
formula: page 14
Value of a firm = Number of customers x CLV
example: p.16
CLV over the entire lifetime of a customer = Initial margin + Margin(retention rate/ (1+ discount rate - retention rate))
Assumptions
- Constant retention rate
- Constant discount rate
- Constant margin
4. If a customer is not retained, then that customer is lost for good?
Prospect Lifetime Value (PLV)
PLV = Profits expected from the prospect - Cost of prospecting
Acquisition rate: proportion of customers that a firm expected to acquire
Acquisition spending: expenditure associated with acquiring a prospect
PLV = (Acquisition rate x CLV) - Acquisition spending per prospect
Average acquisition cost = Acquisition spending/ Number of customers acquired
Average retention cost = Retention spending/ Number of customers retained
CLV (updated) = (Margin - Retention cost) x (Retention rate/ (1 + discount rate - retention rate))
Acquisition vs Retention
Value of firm (under retention) = Number of existing customers x update CLV
Value of firm (under acquisition) = (Number of customers targeted x PLV) + (Number of existing customers x original CLV)