Customer Profitability

Question 1

Companies often think of the profitability of particular

product lines or services.

Answer 1

•Similarly, companies could think of the profitability of serving
a particular customer.
Revenues from a customer $100
Less: Cost of Goods Sold (COGS) $60
= Gross margin for a customer $40
Less expenses for serving a customer $20
= Net profit on the customer $20

Question 2

Customer Profits

Answer 2

•The profit the firm makes from serving a customer or
customer group over a specified period of time.

• The difference between the revenues earned from and the costs associated with the customer relationship during a specified period.
• Purpose: to identify the profitability of individual customers

Question 3

Customer Lifetime Value (CLV)

Answer 3

the present value of the future cash flows
attributed to the customer relationship. Sometimes,
also called “customer equity”.

•Purpose: to assess the lifetime value of each
customer.

CLV represents an upper limit on spending to
acquire new customers.

Question 4

Customer Counts

Answer 4

the number of customers of a firm for a specified time period.

Question 5

Retention rate

Answer 5

= Number of at risk customers retained/ Number of customers at risk

Question 6

Churn rate

Answer 6

= ( 1- retention rate )

Question 7

Present Value ($PV)

Answer 7

$PV = $X / (1 + i)t

Question 8

t is

Answer 8

Discount rate, also called hurdle rate, or opportunity cost of capital: the annual interest rate the firm could obtain by investing the cash.

Question 9

Cost per customer acquired

Answer 9

= total acquisition cost ($) / # of customers acquired

Question 10

Customer Lifetime Value Formula

Answer 10

(M - C) X (r / 1 - r + i) - A

M = margin per customer per period
C = communication (or retention) cost per customer per period
r= retention rate
i= discount rate 
A = acquisition cost per customer

Question 11

Margin Multiple

Answer 11

(r / 1 - r + i)

r= retention rate
i= discount rate

Question 12

Ways to Increase CLV

Answer 12

• Improve customer retention (at what cost)
• Reduce customer acquisition cost
• Reduce promotional and communication costs ?
• Increase margins

Question 13

CLV (market segment)

Answer 13

= CLV of an average customer * number of customers in the market segment

Question 14

CLV without acquisition cost

Customer The value of (a) customers that we have already acquired (but are subject to being lost before we receive another margin), (b) customers that we intend to acquire with a free trial (no initial margin and may not be retained), or (c) customers for whom the initial margin was discounted and included in the acquisition cost.

Answer 14

CLV = [$M – $R] x [(1+d) / (1+d-r)]

CLVrem = ($M - $R) r /1+d-r

$M = $CLV *( 1+d/ 1+d-r) + $R

r = (1 + d) - (($M - $R) * (1+d)) / $CLV

Question 15

Monthly Discount Rate

Answer 15

= ((1 + annual discount rate) ^ 1/12) - 1

Question 16

Monthly retention Rate

Answer 16

= annual retention rate to 1/12 power.