Week 10: Profitability and Pricing 1 - Customer Profitability

Customer level metrics

RFM

2. Frequency: how often does a customer visit a store?

  1. Monetary value: how much does a customer spend in the store?
  1. 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

  1. Constant retention rate
  1. Constant discount rate
  1. 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)