Arthur Middleton HughesVP / Solutions Architect

Customer Retention: how to measure it, build it and keep it.

San Francisco DMA

March 16, 2006

3:00 – 5:00

MarketingDatabase

Analytic &CampaignSoftware

Customer Transactions

Marketing Staff

-Access By Web

Inputs from retail, phone, web

How a Modern Database Works

AppendedData

Modeling &Analytics

Marketing Campaigns

Data CleaningStandardization

Website

Why retention is important: long term loyal customers

• Buy more per year

• Buy higher priced options

• Buy more often

• Are less price sensitive

• Are less costly to serve

• Are more loyal

• Have a higher lifetime value

How to retain them

• Recruit the right customers to begin with

• Once you have them, segment them by lifetime value

• Communicate with them to build loyalty

• Manufacturer of indoor lighting products

• Catalog sent to 45,000 contractors

• Previous policy: wait for the orders

• Test: pick 1,200 customers, split into test of 600 and control of 600

• Two person pilot program build relationship with test customers to see the results

What proves that communications work?

82%

112%

0%

20%

40%

60%

80%

100%

120%

Change in number of

orders

1 2

Control vs Test Groups

Change in the number of orders

86%

114%

0%

20%

40%

60%

80%

100%

120%

Change in average

order size

1 2

Control vs Test Group

Change in the Average Order Size

70%

127%

0%

20%

40%

60%

80%

100%

120%

140%

Change in total

revenue

1 2

Control vs Test Group

Total revenue gain: $2.6 million dollars

Communications work!

Building a relationship with customers can be highly profitable

Using a database to recreate the old family grocer is a winning strategy

Relationship marketing is the way to go

But, with millions of customers…

• Which ones should you spend resources on?

• If you communicate with everyone, you will not have enough resources to retain the very best.

• To select the best, you need to compute customer lifetime value

Lifetime Value

Why we need Lifetime Value Analysis

• We need to know the value of our customers, so as to properly target our sales and retention efforts

• We need to discriminate among our customers to acquire and retain the best

Lifetime Value Analysis Goal: Determine...

• where to put your retention dollars

• the value of each retention strategy

• where to put your acquisition dollars

• how much to spend on acquisition

What is lifetime value?

• Net present value of the profit to be realized on the average new customer during a given number of years.

• To compute it, you must be able to track customers from year to year.

• Main use: To evaluate strategy.

Examples of Profitable Strategies

User Groups

Newsletters

Surveys and Responses

Loyalty Programs

Customer and Technical Services

Membership cards and status levels

Event Driven Communications

Event driven communication:

Dear Mr. Hughes:

I would like to remind you that your wife Helena’s birthday is coming up in two weeks on November 5th. We have the perfect gift for her in stock.

As you know, she loves Liz Claiborne clothing. We have an absolutely beautiful new suit in blue, her favorite color, in a fourteen, her size, priced at $232.00.

If you like, I can gift wrap the suit at no extra charge and deliver it to you next week, so that you will have it in plenty of time for her birthday. Or, I can put it aside so you can come in to pick it up. Please call me at (703) 754-4470 to let me know which you’d prefer.

Sincerely yours,

R ob i n B a u m g a r t n e r Robin Baumgartner, Store Manager

Ridgeway Fashions Leesburg, VA 22069

Lets look at a retail operation

• Before and after a loyalty program

Year 1 Year 2 Year 3Retention Rate 40% 45% 50%Customers 200,000 80,000 36,000 Visits Per Year 1.4 1.6 1.8Spending Per Visit $50 $60 $70Revenue $14,000,000 $7,680,000 $4,536,000

Cost Percentage 50% 49% 48%Costs $7,000,000 $3,763,200 $2,177,280Acquisition Cost $32 $6,400,000Total Costs $13,400,000 $3,763,200 $2,177,280

Profit $600,000 $3,916,800 $2,358,720Discount Rate 1 1.12 1.32NPV Profit $600,000 $3,497,143 $1,786,909Cum NPV Profie $600,000 $4,097,143 $5,884,052Lifetime Value $3.00 $20.49 $29.42

LTV Before New Strategies

Discount Rate Basic Formula

Market Rate of Interest...5%Assume Risk (Double rate)...10%Years = n Interest = iFormula: D = (1 + i)n

Calculation of rate after 2 years: D = (1 + .10)2 = (1.10)2 = 1.21

Provide all customers with a card or register their credit cards

Birthday Club Communicate with them Give them premiums if they

shop a lot Lets see what could happen

New Retention Strategies

With New Strategies

Year 1 Year 2 Year 3Retention Rate 50% 60% 65%Customers 200,000 100,000 60,000 Visits Per Year 1.6 2 2.4Spending Per Visit $55 $70 $80Revenue $17,600,000 $14,000,000 $11,520,000

Cost Percentage 50% 49% 48%Costs $8,800,000 $6,860,000 $5,529,600Acquisition Cost $32 $6,400,000Database Costs $500,000 $250,000 $150,000Loyalty Program $5.00 $8.00 $10.00Loyalty Costs $1,600,000 $1,600,000 $1,440,000Total Costs $17,300,000 $8,710,000 $7,119,600

Profit $300,000 $5,290,000 $4,400,400Discount Rate 1 1.12 1.32NPV Profit $300,000 $4,723,214 $3,333,636Cum NPV Profie $300,000 $5,023,214 $8,356,851Lifetime Value $1.50 $25.12 $41.78

Effect of adoption of new strategies

Year 1 Year 2 Year 3Old LTV $3.00 $20.49 $29.42New LTV $1.50 $25.12 $41.78Change -$1.50 $4.63 $12.36With 200,000 members -$300,000 $926,071 $2,472,799

What is the proper computation period?

• Which is the correct lifetime value? 1, 2, 3, 4, 5 or more years?

• They are all correct. Which you use depends on your product or service.

• Long lifetimes: banks, insurance, utilities.

• Short lifetimes: discount houses, package goods, catalogers.

• Increase the retention rate

• Increase the referral rate

• Increase the spending rate

• Decrease the direct costs

• Decrease the marketing costs

Five Ways to Boost LTV with Database Strategies

How to use lifetime value• Compute a base lifetime value

• Dream up a new strategy. Estimate the benefits and costs

• Determine whether your new lifetime value goes up or goes down

• Don’t undertake any new strategy until you can prove it will be successful

Using lifetime value to get budget approval

• Database marketing budgets are usually carved from somewhere else

• You have to prove that you will make better use of the funds than the others

• Lifetime value can supply testable numbers that CFO’s can understand

• Base your budget on solid numbers backed up by valid tests

What your new budget will buy

Year 1 Year 2 Year 3Old LTV $3.00 $20.49 $29.42New LTV $1.50 $25.12 $41.78Change -$1.50 $4.63 $12.36With 200,000 members -$300,000 $926,071 $2,472,799

How you got there

Year 1 Year 2 Year 3Retention Rate 50% 60% 65%Customers 200,000 100,000 60,000 Visits Per Year 1.6 2 2.4Spending Per Visit $55 $70 $80Revenue $17,600,000 $14,000,000 $11,520,000

Cost Percentage 50% 49% 48%Costs $8,800,000 $6,860,000 $5,529,600Acquisition Cost $32 $6,400,000Database Costs $500,000 $250,000 $150,000Loyalty Program $5.00 $8.00 $10.00Loyalty Costs $1,600,000 $1,600,000 $1,440,000Total Costs $17,300,000 $8,710,000 $7,119,600

Profit $300,000 $5,290,000 $4,400,400Discount Rate 1 1.12 1.32NPV Profit $300,000 $4,723,214 $3,333,636Cum NPV Profie $300,000 $5,023,214 $8,356,851Lifetime Value $1.50 $25.12 $41.78

Using lifetime value to get budget approval

• Database marketing budgets are usually carved from somewhere else

• You have to prove that you will make better use of the funds than the others

• Lifetime value can supply testable numbers that CFO’s can understand

• Base your budget on solid numbers backed up by valid tests

Who is going to defect?

• Besides LTV, you can develop a model that predicts which customers are most likely to leave.

• Putting that model with LTV you can refocus your entire retention strategy

• You create a Risk Revenue Matrix

Focus on A and B: 44% of your customers.

Probability of Leaving SoonLTV High Medium LowHigh Priority A Priority B Priority CMedium Priority B Priority B Priority CLow Priority C Priority C Priority C

Who uses LTV in marketing?*

• DMA survey shows 52% of Consumer Only marketers use LTV.

• 25% of B to B use LTV.

• 49% Larger companies ($100 million or more) use LTV. 32% smaller companies use LTV

• 65% plan to use LTV more extensively in 2006

• 70% use LTV to decide when to reactivate a lapsed customer.

• 68% determine promotions by LTV

*DMA Survey 2005

Conclusion: you can do this

• Create a lifetime value table for your customers.

• Put LTV into each customer record

• Use LTV to determine your marketing strategy

• Use it to improve retention, cross sales, and profits

Break

Why you need customer segments

• Customers are usually very different

• College students, senior citizens, families with children, empty nesters…

• The same message to all may not work so well.

• Solution: create segments, and design a program for each segment.

How one retail store created 9 customer segments.

Segments differ from status levels

Segment Strategy

An ideal segment…

• Has definable characteristics in terms of behavior and demographics: for example, Retired Couples

• Is large enough in terms of potential sales to justify a custom marketing strategy with appropriate rewards and budget

• Has members who can be motivated by cost effective rewards to modify their behavior in ways that are profitable for your company

• Makes efficient use of available data to support segment definition and marketing efforts

• Can be measured in performance, with control groups

• Justifies an organization devoted to it: can be a single person, or part of a person’s time, but there should be someone who “owns” each segment.

A valid segment strategy involves:

• Communications to the segment (direct mail, email, on-location personal attention)

• Rewards designed to modify behavior

• Controls to measure the success of the strategy

• A budget for implementation of the strategy

• Specific goals and metrics for engagement: for behavior modification

• An organization that accepts responsibility for the segment

Segment action plan:

• A roadmap showing what will happen when. “Send each policyholder a birthday card and a policy review 45 days before their policy renewal date.”

• A budget for the infrastructure and for the segment marketing plans

• An organization chart that shows who is responsible for each segment

• Specific goals to be achieved with milestones for measurement of success

Using Clusters as segments

How one non profit measured success by cluster- Their best

Their worst – in terms of response and contributions

Success from mailing only to the best, and not mailing the worst

• $5 Million more in net gross revenue.

Multi-channel users are more loyal

0% 10% 20% 30% 40% 50% 60% 70% 80%

Retail Only

Catalog Only

Web Only

Retail & Catalog

Retail and Web

Catalog & Web

Catalog, retail, web

Retention Rate Year 2

Illustrative numbers from several case studies

Why the web is important to retention

• Web customers are more affluent

• Their average order size is 12% higher than phone orders.

• The cost of the web order is 16% lower than phone orders.

• Typical incentive offered is 5% off on any order over $50.

• Result: 11% of non web customers shift to the web every year.

Creating a club on the internet

• A company selling sporting goods created an internet member club.

• When DB was built they learned that:– Club members bought 11 times more than non club

members.

– In two years, 81% of club members became multi-buyers.

– The club boosted retention

Club Members Retention

80.5%

23.4%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

Goal Club Non Goal Club

Conversion to Multi-Buyers after two years

Cataloger Customer Retention• Miles Kimball sent 20,000 emails with three

different catalogs, and 20,000 with the three catalogs alone.

• Those who got the emails bought 18% more than those who got the catalogs alone.

100

118

90

95

100

105

110

115

120

Control Test

More sales = Higher overall retention levels

Retailer Customer Retention• Video retailer sent email newsletters to 170,000

customers for 6 months.

• Control group of 14,000 got no emails

• Retail sales to test group was 28% more than to those without emails.

100

128

0

20

40

60

80

100

120

140

Control Test

More sales = Higher overall retention levels

One Click Ordering

• With the web we use cookies to say, “Welcome back Susan”.

• We keep her credit card on file if she wants so she can do one click ordering

• Result, compared to controls, is higher retention and annual revenue from those who have one click ordering available.

Tests and controls

• Essential to measuring the effectiveness of retention programs

Why controls are essential

• The sales force acquires new customers

• Database marketers create higher retention rates

• How do you prove this?

• Retention program effectiveness can only be measured using control groups

Every marketing promotion should always be a test

• Test those who get the promotion against the performance of those who do not get the promotion

• If you are sending birthday cards or a newsletter, select 50,000 who do not get birthday cards or the newsletter.

• Look at the control’s spending rate, and retention rate.

• If there is no difference, your cards or newsletters are a waste of money.

What to measure

• Attrition and retention of both groups

• Migration upward and downward

• Incremental sales per program and per season

• Frequency of purchases

• Dollars spent per trip and per season

• Number of departments shopped

• Number of items purchased

• Share of customers’ wallet

Illustration: Birthday Gift

• Get customers to record their birthdays with their emails.

• On their birthday, send them a birthday Pizza Coupon

• One fast food restaurant offered a $10 birthday coupon to 215,000 customers.

• Of the coupons sent out, 86,612 were redeemed ($866,120) producing overall sales of $2,900,000 – a sales increase of $2 million.

Live Agent

• 74% of shopping carts abandoned at checkout.

• Reason: customers have some question. They are unsure about the product, service, color, delivery, etc.

• Solution: put a live chat button at checkout time.

• Have live agents available to answer questions.

• Result: increased retention and sales

Caller ID

• Use Caller ID to bring customer’s complete purchasing history on the screen before the agent begins talking.

• Result, she can talk to the customer as if she knew her.

• Result: Increased retention. Greater opportunity for cross sales.

What should you do to keep your customers?

• Select loyal customers to begin with. Reward agents for customer loyalty.

• Set up a customer communications plan

• Calculate LTV of each customer

• Use modeling to predict churn and to determine the Next Best Product

• Combine LTV and NBP to run a proactive retention program

• Optimize your inducements

Books by Arthur Hughes

From McGraw Hill. Order at www.dbmarketing.com Contact Arthur: arthur.hughes@kbm1.com