Customer Based Value Metrics

Customer Based Value Metrics
Popular Customer-Based Value

Metrics
Size-of-Wallet
J

j 1
• Size-of-wallet ($) of customer in a category = Sj
Where: Sj 
=j 1sales to the focal customer by the firm j
j = firm, = summation of value of sales made by all the J firms that
sell a category of products to the focal customer
Information source:
Primary market research
Evaluation:
Critical measure for customer-centric organizations based on the assumption
that a large wallet size indicates more revenues and profits
Example:
A consumer might spend an average of $400 every month on groceries
across the supermarkets she shops at. Her size-of-wallet is $400
Share-of-Wallet (SW)
• Individual Share-of-Wallet
J
– Individual Share-of-Wallet of firm to customer (%) = Sj / 

j Sj
1
Where: S = sales to the focal customer, j = firm,

= summation of
j 1 value of sales made by all
the J firms that sell a category of products to a buyer
Information source:
Numerator: From internal records
Denominator: From primary market research (surveys), administered to individual customers,
often collected for a representative sample and then extrapolated to the entire buyer base
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
Share of Category Requirement (SCR)
I I J
• SCR (%) of firm or brand in category =  Vij /  Vij

i 1
i 1 j 1
j = firm, V = purchase volume, i = those customers who buy brand

I
 = summation of volume purchased by the I customer from a

i 1
firm j,
J

I
j 1 i 1 = summation of volume purchased by all I customers from all j firms
Information source:
Numerator: volumetric sales of the focal firm - from internal records
Denominator: total volumetric purchases of the focal firm’s buyer base- through market and
distribution panels, or primary market research (surveys) and extrapolated to the entire buyer base
Evaluation:
Accepted measure of customer loyalty for FMCG categories, controls for the total volume of
segments/individuals category requirements; however, does not indicate if a high SCR customer
will generate substantial revenues or profits

Segmenting Customers Along
Share of Wallet and Size of Wallet
Maintain and guard

High
Hold on
Share-of-wallet
Target for
Do nothing additional selling
Low
Small Large
Size-of-wallet
The matrix shows that the recommended strategies for different segments differ
substantially. The firm makes optimal resource allocation decisions only by
segmenting customers along the two dimensions simultaneously
Strategic Customer Based Value Metrics
• RFM
• LTV Metrics
• Customer Equity
RFM
• 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

Computation of RFM
Two common methods:
• Method 1: Sorting customer data based on RFM, grouping and

analyzing results
• Method 2: Computing relative weights for R,F and M using

regression techniques
– RFM (categorical variables) as IVs, sales/revenue/redemption rates as DVs
Example: How to identify responsive
customers
• Some customers respond to marketing tactics (e.g.,
coupons), some don’t
• How can you predict behavior?
• Best method: look at past behavior
• Behavioral indicators:
– Recent purchasers
– Frequent purchasers
– Large spenders
Takeaway
• In this product’s case, clearly, Recency is a more meaningful
indicator of discount coupon redemption than the Frequency or
Monetary value
• Therefore, it pays off if marketing undertakes these analyses for

each type of product category, and finds out which is a meaningful
indicator for that category/type of campaign
• E.g., Sears mailer

– Monetary value was found to be a meaningful indicator
– Sales increased by US$ 225 million
• These are ways of segmenting your customer base

RFM Can Predict Responders
• Use RFM to select most likely responders
• Use combination of mail, phone, and emails to responsive

relationship buyers
RFM Method 2- Regression Method
• Regression techniques to compute the relative weights of the R, F, and M

metrics
• Relative weights are used to compute the cumulative points of each customer
• The pre-computed weights for R, F and M, based on a test sample are used
to assign RFM scores to each customer
• The higher the computed score, the more profitable the customer is likely to
be in the future
• This method is flexible and can be tailored to each business situation

Past Customer Value
• Computation of Customer Profitability
n
  GCin * (1  r ) n
• Past Customer Value of a customer n 1
Where I = number representing the customer, r = applicable discount rate

n = number of time periods prior to current period when purchase was made
GCin = Gross Contribution of transaction of the i th customer in the nth time period
• Since products/services are bought at different points in time during the customer’s lifetime,
all transactions have to be adjusted for the time value of money
• Limitations: Does not consider whether a customer is going to be active in the future. Also
does not incorporate the expected cost of maintaining the customer in the future
Lifetime Value metrics
(Net Present Value models)
• Multi-period evaluation of a customer’s value to the firm
Recurring
Revenues
Contribution
margin
Recurring
costs
Lifetime of a
customer
Lifetime Profit
LTV
Discount Acquisition
rate cost
Life-time value defined
• Life-time value is the present day value of all net margins
earned from a relationship with a customer, customer segment
or cohort
– To compute LTV, all historic net margins are compounded

up to today’s value and all future net margins are discounted
back to today’s value
– A customer that appears to be valuable on the basis of the

gross margins generated will most likely be less profitable
once cost-to-serve the customer is taken into account
Profit Over Time – Credit Cards
profit per customer

60
40
20
0
-20
-40
-60
0 1 2 3 4 5
Year
Reichheld and Sasser HBR 90508

Cohort
What is a Cohort?
Cohort Value: The Impact of Customer
Retention Rate
Year Profit per NPV at Customer No. of Total annual
customer 15% discount retention rate Customers profit
(%)
0 -100 100,000 -10,000,000

1 50 43.48 60 60,000 2,608,800
2 70 52.93 70 42,000 2,223,062
3 100 65.75 75 31,500 2,071,125
4 140 80.00 80 25,200 2,016,000
5 190 94.53 85 21,420 2,024,776
6 250 108.23 90 19,278 2,086,364
7 320 120.30 92 17,736 2,133,654
8 400 130.72 94 16,672 2,179,346
9 450 127.84 95 15,838 2,024,744
10 500 123.15 96 15,204 1,872,372
Five Ways to Boost LTV with DB
Strategies
• Increase the retention rate
• Increase the referral rate
• Increase the spending rate
• Decrease the direct costs
• Decrease the marketing costs

Core Strategies to Improve Cohort
Profitability
1. Improve customer retention rate in the early years of the
relationship. This will produce a larger number of customers to
generate higher profits in the later years
2. Increase the profit earned per customer by

– Reducing cost-to-serve
– Cross-selling or up-selling additional products and services
3. Become better at customer acquisition by

– Using more cost effective recruitment channels
– Better qualification of prospects. Customers who defect early
on perhaps should not have been recruited in the first place
Calculation of Lifetime Value: Simple Definition
t
T
 1 
LTV   CM t  
t 1  1   
where LTV = lifetime value of an individual customer in $, CM = contribution margin,

 = interest rate, t = time unit,  = summation of contribution margins across time
periods
• LTV is a measure of a single customer’s worth to the firm

• Used for pedagogical and conceptual purposes
Information source:
CM and T from managerial judgment or from actual purchase data.
The interest rate, a function of a firm’s cost of capital, can be obtained from financial accounting
Evaluation:
Typically based on past customer behavior and may have limited diagnostic value for future
decision-making
LTV: Definition Accounting for
Acquisition Cost and Retention Probabilities
t
 T  T
  1  
LTV      Rr CM it     AC
 t 1  t 1  1   
Where, LTV = lifetime value of an individual customer in $

Rr = retention rate
П = Product of retention rates for each time period from 1 to T,
AC = acquisition cost
T = total time horizon under consideration
Assuming that T   and that the contribution margin CM does not vary over time,
CM
LTVi   AC
1  Rr  
Customer Equity
• Sum of the lifetime value of all the customers of a firm
t
I T
 1 
• Customer Equity, CE    CM it  
i 1 t 1  1   
• 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 /

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

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Customer Based Value Metrics

Popular Customer-Based Value

Primary market research

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

Where: S = sales to the focal customer, j = firm,

Numerator: From internal records

Denominator: From primary market research (surveys), administered to individual customers,

Important measure of customer loyalty; however, SW is unable to provide a clear indication of

• 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 the I customer from a

j 1 i 1 = summation of volume purchased by all I customers from all j firms

will generate substantial revenues or profits

Maintain and guard

• Frequency-how often a customer orders from the company in a

• Monetary value- the amount that a customer spends on an average

• Tracks customer behavior over time

Two common methods:

• Method 1: Sorting customer data based on RFM, grouping and

• Method 2: Computing relative weights for R,F and M using

• How can you predict behavior?

• Best method: look at past behavior

• Therefore, it pays off if marketing undertakes these analyses for

• E.g., Sears mailer

• These are ways of segmenting your customer base

• Use combination of mail, phone, and emails to responsive

• Regression techniques to compute the relative weights of the R, F, and M

• This method is flexible and can be tailored to each business situation

Where I = number representing the customer, r = applicable discount rate

– To compute LTV, all historic net margins are compounded

– A customer that appears to be valuable on the basis of the

profit per customer

Reichheld and Sasser HBR 90508

0 -100 100,000 -10,000,000

• Increase the referral rate

• Increase the spending rate

• Decrease the direct costs

• Decrease the marketing costs

2. Increase the profit earned per customer by

3. Become better at customer acquisition by

where LTV = lifetime value of an individual customer in $, CM = contribution margin,

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

Where, LTV = lifetime value of an individual customer in $

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

• Customer Equity Share, CESj = CEj /

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

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