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Re: evaluating customers' lifetime value

From: Jim Novo <jimnovo_at_sprintmail.com>
Date: Thu 6 Apr 2000 17:55:31 -0400

VIDA J MORKUNAS WROTE:
> I work for a national click and mortar retail leader,
> and was recently tasked with determining hard metrics
> for customer lifetime value. I am looking for
> reference articles and case studies that would help me
> define a monetary model for aggregates of customers.

LTV is a pretty straightforward calc....define the
length of time you will use, measure sales, subtract
COG, subtract service / admin overhead, subtract
promotional costs = LTV.

The challenge is usually most of the data you need to
complete the simple calc is not available, or can't be
agreed upon by all the players.

If you don't know what the average unit returned costs
you in terms of overhead, you can't do the calc. If
you don't know what the avg number of customer service
calls per unit shipped is and what they cost, you can't
do the calc. This is a particularly difficult problem
for offline retailers, who don't have a database that
captures near enough relevant data.

Here's how I'd approach it:

Focus on the average unit sold, and try to get break up
all the components that comprise the unit. Once you
get to a profit / unit, just multiply by units sold to
customer group over the "lifetime", minus promotional
costs, and you get LTV.

Average price, COGS, gross margin...should be easy. To
get customer service costs, look at how many units you
move annually, and divide by annual cust service cost.
Returns the same thing, on down the line, until you
know the costs / unit sold of all the elements going
into a sale. Don't forget credit processing, after
sale support, etc.

If you find this impossible, a proxy might be found in
your company's annual income statements. Take your
annual net income and divide by units sold. This
number will be contaminated by all kinds of
adjustments; perhaps finance could help you "add back"
to income items not really related to selling units.

These things might include goodwill, tax related items,
acquisition costs, etc. If it doesn't directly affect
the sale of a unit, back it out. This will no doubt be
a lively discussion, but it is at the heart of a
company wide argeement on how to define LTV and what
costs should be allocated to the sale of a unit.

For example, would you have a web site as a "cost of
doing good business and servicing our customers", so it
would exist anyway, regardless of whether sales were
made on it or not? If that's true, then allocate only
the costs involved in order processing, not "the whole
site".

This is great fun and you'll finally get to bond with
that finance guy you eat lunch with sometimes...

The hardest part of an LTV calc is getting everybody to
agree what a "lifetime" is, particularly if (as is the
case with most offline retailers), you don't really
have a database of all your customers.

Look at the average length of time from start to stop
in the group you are profiling, and use that as a
lifetime. If you don't have this info, try asking
credit card companies you work with to provide it. If
the business is new, and you think everybody is "still
shopping", pick a reasonable number, say 2 years, and
extrapolate.

I wouldn't add anything you can't measure (value of an
e-mail subscription?), just assume any positive or
negative contribution it makes is already reflected in
sales...

Once you have the "average" LTV, if you're trying to
segment LTV's for different groups, make assumptions
and adjust. Web based customers make less or more calls
to customer service? Return rates higher or lower?

If you can't break this out, use the sales/COGS/gross
margins unique to each group, and assume the "overhead"
(cust service, warehouse, etc.) is the same across
all...

And finally, subtract the cost of promotion to each
group, advertising, discounts given, etc. and you'll
have LTV. If you don't track this, allocate as
examples above.

Don't be surprised if you find some customer groups
have negative LTV's - very common. This is the part of
LTV analysis usually forgotten, because it literally
means you would be more profitable if you had less
customers.

And explaining that to your boss is often a challenge.

Good luck!

Jim Novo
Marketing Mercenary
jimnovo_at_sprintmail.com




Received on Thu Apr 06 2000 - 16:55:31 CDT


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