# 5 customer metrics

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5 Customer MetricsTRANSCRIPT

Customer Metrics

� Adapted from the textbook, “Marketing Metrics”by Farris, Bendle, Pfeiffer & Reibstein,2nd edition, Pearson Education

� Articles from Research and Practitioner journals

Recap

�Sales volume is composed of two factors

�Two marketing factors that affect trial rate

�Formula for CAGR

�Define cannibalization

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Session Objectives

�By the end of the session, students will be able

to:

� Appreciate the usefulness of customer metrics

� Understand basic, popular and strategic customer

metrics adopted by organizations

� Learn to focus marketing tactics on customer

portfolios based on strategic metrics

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Customer Metrics

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Customer Metrics

Primary

Acquisition

Retention

P(Active)

Popular

Share of Wallet

Share of Category

Strategic

RFM

CLV

CE

Acquisition Rate & Cost

�Acquisition Rate (%)

� First purchase or purchasing in the first predefined period

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� Typically computed on a campaign-by-campaign basis

�Acquisition Cost ($)

�Acquisition spending ($)

Number of prospects acquired

� Precise values for companies targeting prospects

through direct mail

� Less precise for broadcasted communication

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Retention and Defection

�Retention rate (%) = "Number of customers incohort buying in (t)| buying in (t−1)" /"Numberof customers in cohort buying in (t−1) "

�Avg. Defection rate (%) = 1 – Avg. Retentionrate

�Assuming constant retention rates, number ofretained customers in any arbitrary period(t+n)

�= Number of acquired customers in cohort *Retention rate (t+n)

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Example

� If the average retention rate is 0.75 or 75% per year. i.e., on an average, 75% of

the customers remain customers in the next period

� The effect for a cohort of customers over time – out of 100 customers who start

in year 1, about 32 are left at the end of year 4

Customers starting at the beginning of year 1: 100.00

Customers remaining at the end of year 1: 75.00 (0.75*100)

Customers remaining at the end of year 2: 56.25 (0.75*75)

Customers remaining at the end of year 3: 42.18 (0.75*56.25)

Customers remaining at the end of year 4: 31.64 (0.75*42.18)

Assuming constant retention rates, the number of retained customers at theend of year 4 is 100*(0.75)4 = 31.64. (Number of acquired customers in cohort *Retention rate (t+n) )

The defection rate is 1-0.75 = 0.25 or 25%

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P (Active)

�Probability of a customer being active in time t

�P(Active) = Tn

� where, n is the number of purchases in a given period , T isthe time of the last purchase (expressed as a fraction ofthe observation period)

�To compute the P(Active) of each of the two customersin the 12th month of activity (recent purchase in 8th month)

For Customer 1: T = (8/12) = 0.6667 and n = 4P(Active)1= (0.6667)4 = 0.197

And for Customer 2: T = (8/12) = 0.6667 and n = 2P(Active)2= (0.6667)2 = 0.444

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Share of Category Requirement (SCR)

� SCR (%) of firm or brand in category = Vij / Vij

j = firm, V = purchase volume, i = those customers who buy brand

= summation of volume purchased by all the I customers from a firm j

= summation of volume purchased by all I customers from all j firms

� Accepted measure of customer loyalty for FMCG categories, controls for

the total volume of segments/individuals category requirements;

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JJJJ1111jjjjTotal requirement of

Notebook computers

per customer

(A)

Total no. of Notebook

Computers purchased

from ABC Computers

(B)

SCR for ABC computers

per customer per period

(B/A)

Customer 1 100 20 0.20

Customer 2 1000 200 0.20

Customer 3 2000 500 0.25

Share-of-Wallet (SW)

� Individual Share-of-Wallet� Individual Share-of-Wallet of firm to customer (%) = Sj / Sj

S = sales to the focal customer

j = firm

= summation of value of sales made by all the J firms that sell a

category of products to a buyer

�Evaluation:

Important measure of customer loyalty; however, SW is unable to

provide a clear indication of future revenues and profits that can be

expected from a customer

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Share of Wallet

�Aggregate Share-of-Wallet (ASW) (brand or

firm level)

� Aggregate Share-of-Wallet of firm (%)

= Individual Share-of-Walletji / number of customers

= Si / Sij

S = sales to the focal customer, j = firm, i = customers who buy

brand

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Applications of SCR and SW

�SCR -for categories where the variance ofcustomer expenditures is relatively small

�SW - if the variance of consumer expenditures isrelatively high

�Share-of-wallet and Size-of-walletsimultaneously – with same share-of-wallet,different attractiveness as customers:

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Share-of-

Wallet

Size-of-

Wallet

Absolute expenses

with firm

Buyer 1 50% $400 $200

Buyer 2 50% $50 $25

Absolute attractiveness of Buyer 1 eight times higher than buyer 2

Segmenting Customers Along Share & Size of Wallet

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High

Share-of-wallet

Low

Size-of-wallet

Hold on

Do nothing

Target for additional selling

Maintain and guard

Small Large

RFM (Recency, Frequency, Monetary Value)

�Recency, Frequency and Monetary Value-applied on

historical data

�Recency -how long it has been since a customer last

placed an order with the company

�Frequency-how often a customer orders from the

company in a certain defined period

�Monetary value- the amount that a customer

spends on an average transaction

�Tracks customer behavior over time in a state-space

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RFM - Regression Method

�Regression techniques to compute therelative weights of the R, F, and M metrics

�Relative weights are used to compute thecumulative points of each customer

�The pre-computed weights for R, F and M,based on a test sample are used to assignRFM scores to each customer

�The higher the computed score, the moreprofitable the customer is likely to be in thefuture

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Recency Score

�20 if within past 2 months; 10 if within past 4 months;05 if within past 6 months; 03 if within past 9 months;01 if within past 12 months; Relative weight = 5

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Customer Purchases

(Number)

Recency

(Months)

Assigned

Points

Weighted Points

1 2 20 100

JOHN 2 4 10 50

3 9 3 15

SMITH 1 6 5 25

1 2 20 100

MAGS 2 4 10 50

3 6 5 25

4 9 3 15

Frequency Score

�Points for Frequency: 3 points for each purchasewithin 12 months; Maximum = 15 points; Relativeweight = 2

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Customer Purchases(#) Frequency Assigned

Points

Weighted

Points

1 1 3 6

JOHN 2 1 3 6

3 1 3 6

SMITH 1 2 6 12

1 1 3 6

MAGS 2 1 3 6

3 2 6 12

4 1 3 6

Monetary Value Score

� Monetary Value: 10 percent of the $ Volume of Purchase

within 12 months; Maximum = 25 points; Relative weight = 3

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Customer Purchases

(Number)

Monetary Assigned

Points

Weighted

Points

1 $40 4 12

JOHN 2 $120 12 36

3 $60 6 18

SMITH 1 $400 25 75

1 $90 9 27

MAGS 2 $70 7 21

3 $80 8 24

4 $40 4 12

RFM Cumulative Score

� Cumulative scores: 249 for John, 112 for Smith and 308 for Mags; indicate apotential preference for Mags

� John seems to be a good prospect, but mailing to Smith might be amisdirected marketing effort

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Customer Purchases

(Number)

Total Weighted Points Cumulative Points

1 118 118

JOHN 2 92 210

3 39 249

SMITH 1 112 112

1 133 133

MAGS 2 77 210

3 61 271

4 37 308

Calculation of Lifetime Value: Simple Definition

� LTV = lifetime value of an individual customer in $, CM =contribution margin, δ = interest rate, t = time unit, Σ =summation of contribution margins across time periods

� LTV is a measure of a single customer’s worth to the firm

� CM and T from managerial judgment or from actualpurchase data.

� The interest rate, a function of a firm’s cost of capital, canbe obtained from financial accounting

� Typically based on past customer behavior and may havelimited diagnostic value for future decision-making

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LTV formula - Infinite Time Period (Gupta & Lehman)

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where

LTV = lifetime value

m = margin or profit from a customer per period

r = retention rate (e.g. 0.8 or 80%)

i = discount rate (e.g. 0.12 or 12%)

LTV = m(�

,-".�)

Margin multiples to calculate CLV

�Store A – Retention rate – 70%; Margin – Rs 40

�Store B – Retention rate – 80%; Margin – Rs 35

�WACC – 12%

�Calculate CLV of a customer in both shops. Which storehas higher CLV customers?

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RETENTION RATE

DISCOUNT RATE

10% 12% 14% 16%

60% 1.20 1.15 1.11 1.07

70% 1.75 1.67 1.59 1.52

80% 2.67 2.50 2.35 2.22

90% 4.50 4.09 3.75 3.46

Customer Equity

� Sum of the lifetime value of all the customers of a firm

� Customer Equity,

� Indicator of how much the firm is worth at a particular point in

time as a result of the firm’s customer management efforts

� Can be seen as a link to the shareholder value of a firm

� Customer Equity Share, CESj = CEj / k,

where, CE = customer equity , j = focal brand, k = all brands

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CLV Exercise

� M/s XYZ is a seller of power drills. They sell four models targeted at differentsegments. Sales are achieved through industrial dealers.

� Customer acquisition is done through a combination of advertising and salespromotion (A&SP).

� They have spent Rs 16 crores on the four products to acquire customers in proportionto the margin delivered by each product.

� Company has additional revenue stream through consumables and repairs.Consumables have to be replaced every year to customers. Usually customers spendsome amount on repairs during Year 3 of operations.

� Life of product is five years

� Calculate LTV for each product. Which product is attractive in terms of total cash flowgenerated for the company?

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ProductPrice /

unit (Rs)

Sales

(nos)Margin

Consumable

Cost Margin

Repair

CostMargin

A 3500 250,000 15% 100 10% 500 25%

B 6000 120,000 18% 250 15% 750 25%

C 8000 75,000 22% 300 25% 1000 25%

D 12000 15,000 30% 1000 40% 2000 25%

CLV Exercise

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ProductPrice /

unit (Rs)Margin

Sales

(nos)Margin earned (Rs)

% contribution

to Margin

Acquisition Cost

(Rs)

A 3500 15% 250000 131,250,000 29 46,995,636

B 6000 18% 120000 129,600,000 29 46,404,834

C 8000 22% 75000 132,000,000 30 47,264,183

D 12000 30% 15000 54,000,000 12 19,335,347

446,850,000 100 160,000,000.00

Consumables Replacement

Year 1 Year 2 Year 3 Year 4 Year 5 Year 3

2500000 2500000 2500000 2500000 2500000 31250000

4500000 4500000 4500000 4500000 4500000 22500000

5625000 5625000 5625000 5625000 5625000 18750000

6000000 6000000 6000000 6000000 6000000 7500000

CLV Exercise

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PV of Cash Flow

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Total %

A 84,254,364 2272727 2066116 25356875 1707534 1552303 117,209,918 28

B 83,195,166 4090909 3719008 20285500 3073561 2794146 117,158,290 28

C 84,735,817 5113636 4648760 18313298 3841951 3492682 120,146,145 29

D 34,664,653 5454545 4958678 10142750 4098081 3725528 63,044,234 15

417,558,588