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Using Lifetime Value to Determine Your Marketing

Strategy

Arthur Middleton Hughes, VP Strategic Planning msdbm

www.msdbm.com

DMA 84th Annual Conference

McCormick Place Chicago

Oct 29th 2001 2:45 PM

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Client Roster --

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Compared with newcomers, Long term customers: Buy more per yearBuy higher priced optionsBuy more oftenAre less price sensitiveAre less costly to serveAre more loyalHave a higher lifetime value

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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Percentage Retained

from Previous

Year

1 2 3 4 5

Years as a customer

Retention is the way to measure loyalty

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Retention pays better than acquisition

($62)

$48

($80)($60)($40)($20)

$0$20$40$60

New Customer 3rd YearCustomer

Annual Profit

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Two Kinds of Database People

Constructors

People who build databases

Merge/Purge, Hardware, Software

Creators

People who understand strategy

Build loyalty and repeat sales

You need both kinds!

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GOLD Spend Service Dollars Here

Spend Marketing Dollars Here

Reactivate or Archive

Your Best Customers - 80% of Revenue

Your Best Hope for New Gold Customers

Move Up

1% of Total Revenue These may be losers

Marketing to Customer Segments

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Examples of Profitable Strategies

NewslettersSurveys and ResponsesLoyalty ProgramsCustomer and Technical ServicesFriendly, interesting interactive web siteEvent Driven Communications

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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,

Robin Baumgartner Robin Baumgartner, Store Manager

Ridgeway Fashions

Leesburg, VA 22069

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Manufacturer of building productsCatalog sent to 45,000 contractorsPrevious policy: wait for the ordersTest: pick 1,200 customers, split into test of

600 and control of 600Two person pilot program build relationship

with test customers to see the results

Credit: Hunter Business Direct

What proves that relationship building works?

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What did they offer?

Follow up on bids and quotesSchedule product trainingMake aware of pricing specialsAsk about customer needsProduct comparison informationNew Product informationThey did not offer discounts

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73%

76%

72%72%73%73%74%74%75%75%76%76%

Percent who

purchased in 6 months

1 2

Control vs Test Group

Improvement in Response rate

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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

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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

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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

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This stuff works!

Building a relationship with customers can be highly profitable

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

Business to business relationship marketing is the way to go

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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

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Lifetime Value Analysis Goal: Determine...

where to put your retention dollarsthe value of each retention strategywhere to put your acquisition dollarshow much to spend on acquisition

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What is lifetime value?

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

Lifetime value is “Good Will.”To compute it, you must be able to

track customers from year to year.Main use: To evaluate strategy.

Weldon Instruments Before New Strategy

Revenue Year1 Year2 Year3Customers 30,000 22,355 18,523Retention Rate 74.52% 82.86% 85.00%Spending Rate $19,500 $20,280 $22,400Total Revenue $585,000,000 $453,359,400 $414,915,200

CostsDirect Percent 75.00% 65.00% 60.00%Direct Costs $438,750,000 $294,683,610 $248,949,120Acquisition Cost $630 $18,900,000 $0 $0Total Costs $457,650,000 $294,683,610 $248,949,120

ProfitsGross Profit $127,350,000 $158,675,790 $165,966,080Discount Rate 1.21 1.37 1.51NPV Profit $105,247,934 $115,821,745 $109,911,311Cumulative NPV Profit $105,247,934 $221,069,678 $330,980,990

Customer lifetime value $3,508.26 $7,368.99 $11,032.70

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Market Rate of Interest...8%Assume Risk (Double rate)...16%Years = n Interest = iFormula: D = (1 + i)n

Calculation of rate after 3 years: D = (1 + .16)3 = (1.16)3 = 1.56

Discount Rate Basic Formula

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Market Rate of Interest...8.4%Calculate risk factor…r..1.8Calculate payment time … (12/Months)Interest = i n+t = (n years + t pay time)Formula: D = (1 + i*r)n+t

Calculation of rate after 3 years: D = (1 + .084*1.8)3.25 = (1.15)3.25 = 1.60

Discount Rate Complex Formula

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Annual Rate = (Repurchase rate) (1/years)

77% repurchase after 11 years Annual Rate = (.77)(1/11) = 98%45% repurchase after 4 years = 82%99% per week = 59.2% per yearAnnual = (.99) (1/(1/52))

Annual Rate = 59.2%

Convert to Annual

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Put 45,000 pages of tech info on web

Create extranet for Gold & Silver Custs.

24 hour email response timeTotal cost of these strategies

$450/custReferral Program with $800

incentives

New Retention Strategies

Weldon with new strategiesRevenue Year1 Year2 Year3Referral Rate 5.00% 6.00% 7.00%Referred Customers - 1,500 1,620 Retention Rate 85.00% 88.00% 90.00%Retained Customers - 25,500 23,760 Total Customers 30,000 27,000 25,380 Spending Rate $21,000 $24,000 $27,000Total Revenue $630,000,000 $648,000,000 $685,260,000

CostsDirect Percent 75.00% 65.00% 60.00%Direct Costs $472,500,000 $421,200,000 $411,156,000Acquisition Cost $630 $18,900,000 0 0Retention Building Program $450 $13,500,000 $12,150,000 $11,421,000Referral Program Costs $800 $0 $1,200,000 $1,296,000Total Costs $504,900,000 $434,550,000 $423,873,000

ProfitsGross Profits $125,100,000 $213,450,000 $261,387,000Discount Rate 1.21 1.37 1.51Net Present Value Profit $103,388,430 $155,802,920 $173,103,974Cumulative NPV Profit $103,388,430 $259,191,349 $432,295,323Customer Lifetime Value $3,446.28 $8,639.71 $14,409.84

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Effect of adoption of new strategies

Year1 Year2 Year3New LTV $3,446.28 $8,639.71 $14,409.84

Old LTV $3,508.26 $7,368.99 $11,032.70

Difference -$61.98 $1,270.72 $3,377.14

With 30,000 Customers -$1,859,400 $38,121,600 $101,314,200

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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.

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Increase the retention rateIncrease the referral rateIncrease the spending rateDecrease the direct costsDecrease the marketing costs

Five Ways to Boost LTV with DB Strategies

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How to use lifetime value

Compute a base lifetime valueDream up a new strategyEstimate the benefits and costsDetermine whether your new lifetime value

goes up or goes downDon’t undertake any new strategy until you

can prove it will be successful

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Find LTV of Customer Segments

Many B-t-B customers are quite different in their purchase patterns

Create actionable segments and determine the value of each

Use the results to focus your retention programs and acquisition programs on the most profitable segments

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Dividing Customers into Four Segments

Weldon Instruments Corporation Customer SegmentsAverage Total Sales Lifetime LTV

Customers Sale Sales Ranking Value Ranking

Metal Production 254 $339,736 $86,293,000 4 $145,067.37 2Light Manufacturing 15442 $13,851 $213,892,000 1 $5,914.51 4Heavy Manufacturing 44 $2,314,159 $101,823,000 3 $988,145.93 1High Technology 612 $299,007 $182,992,000 2 $127,675.79 3Total 29,198 $20,036 $585,000,000 $8,555.74

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Focus on Retention

Where should Weldon's Retention Dollars Go?Weldon Lifetime

Customers Value Rank

Metal Production 254 $145,067 2Light Manufacturing 15,442 $5,914 4Heavy Manufacturing 44 $988,145 1High Technology 612 $127,675 3Total 29,198

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Weldon’s Acquisition Focus

It is easier to acquire customers where you are well known: where you have a high penetration ratio.

Weldon has only 3% of heavy manufacturing.They have 42% of the High Technology.The return from concentration on high

technology will probably be greater.

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Focus on Acquisition by LTV

Where are Weldon's Prime Acquisition Targets?Weldon US Penetration Lifetime Target Rank

Customers Universe Ratio Value Potential

Metal Production 254 2,433 10.44% $145,067 $15,144.68 3Light Manufacturing 15,442 162,009 9.53% $5,914 $563.70 4Heavy Manufacturing 44 1,288 3.42% $988,145 $33,756.51 2High Technology 612 1,453 42.12% $127,675 $53,776.39 1Total 29,198 167,183 17.46%

Target Potential = LTV * Penetration Ratio

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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

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What your new budget will buy

Year1 Year2 Year3New LTV $3,446.28 $8,639.71 $14,409.84

Old LTV $3,508.26 $7,368.99 $11,032.70

Difference -$61.98 $1,270.72 $3,377.14

With 30,000 Customers -$1,859,400 $38,121,600 $101,314,200

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Revenue Year1 Year2 Year3Referral Rate 5.00% 6.00% 7.00%Referred Customers - 1,500 1,620 Retention Rate 85.00% 88.00% 90.00%Retained Customers - 25,500 23,760 Total Customers 30,000 27,000 25,380 Spending Rate $21,000 $24,000 $27,000Total Revenue $630,000,000 $648,000,000 $685,260,000

CostsDirect Percent 75.00% 65.00% 60.00%Direct Costs $472,500,000 $421,200,000 $411,156,000Acquisition Cost $630 $18,900,000 0 0Retention Building Program $450 $13,500,000 $12,150,000 $11,421,000Referral Program Costs $800 $0 $1,200,000 $1,296,000Total Costs $504,900,000 $434,550,000 $423,873,000

ProfitsGross Profits $125,100,000 $213,450,000 $261,387,000Discount Rate 1.21 1.37 1.51Net Present Value Profit $103,388,430 $155,802,920 $173,103,974Cumulative NPV Profit $103,388,430 $259,191,349 $432,295,323Customer Lifetime Value $3,446.28 $8,639.71 $14,409.84

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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

10866 Wilshire Blvd., Suite 650Los Angeles, CA 90024-4354

Phone (310) 208-2024Fax (310) 208-5681www.msdbm.com

www.dbmarketing.com

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Arthur Hughes, Vice President for Strategic Planning of msdbm Marketing in Los Angeles, (www.msdbm.com) has been designing and maintaining marketing databases for Fortune 500 companies and others for the past sixteen years. His database experience includes telephone companies, banks, pharmaceuticals, package goods, software and computer manufacturers, resorts, hotels, automobiles, and non-profit fund raisers.

A graduate of Princeton University with a Masters in Public Affairs, Arthur taught economics at the University of Maryland for 32 years. He lectures in the U. S., Canada, Europe, Latin America and Asia on marketing and economics. When it comes to Database Marketing, he wrote the book! He is the author of The Complete Database Marketer: Tapping your customer base to maximize sales and increase profits. 2nd Ed. (McGraw Hill 1996), and Strategic Database Marketing (McGraw Hill 2000).

Arthur's articles have appeared in leading publications. He has served as a key speaker in marketing conferences in the U.S., Canada, U.K., Japan, Taiwan, Australia, Brazil, Venezuela, Malaysia and Portugal. M\S are leaders in Customer Management and Internet Marketing. Arthur may be reached at (703) 525-9637 Fax 703 351 7417 or at ahughes@msdbm.com

About the speaker

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THE COMPLETE DATABASE MARKETERby Arthur Middleton Hughes

Chicago: McGraw Hill 600 pp GlossaryRevised Edition 1996

This is the bible of database marketing. Over 16,000 copies sold. John Stevenson Exec. VP of Krupp Taylor: "Not only does this book succeed in being clear and accessible, it is also the first complete treatise...The full power and practice of database marketing are here, to be sure. This is the long awaited survival manual for every marketer on the cutting edge. I can't think of a book that is more rewarding."

This comprehensive book covers such subjects as how to build customer loyalty, lifetime value calculation, RFM analysis, customer service, telemarketing, fulfillment, hardware and software, clustering and profiling, prospecting, media selection. Order from www.DBMarketing.com

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STRATEGIC DATABASE MARKETINGby Arthur Middleton Hughes

Chicago: McGraw Hill 2000 400 pp

Millions have been spent on database marketing pro grams that did not work. In this book Arthur Hughes shows how to evaluate strategies in advance using life time value analysis. He explains how to use RFM analysis to boost profits. Russ Richmond, President of Grey Direct said: "Well, Arthur has done it again. He has not only integrated the complicated world of data bases with the traditional concepts of direct marketing, but he accurately points out the pitfalls and the how-tos. I know of a few careers that would have been saved had this book been available sooner. Without a doubt this will be the cheapest investment you'll make in your database, and perhaps the most important one." Thousands of customer marketing databases are being built. Unfortunately, many mistakes have been made. The reasons for these failures center on one central fault: the inability of marketers to develop logical, practical and winning strategies for their database marketing programs. We must study past mistakes to develop sound principles for marketing strategy. Order from www. DBMarketing.com