Two Sides of Customer Value:
Economic Value to the Customer
(EVC)
and
Life Time Value of a Customer (LTV)
Session 4
Marketing Management
Prof. Natalie Mizik
Marketing Management:
The Big Picture
I. Situation
Analysis
(5Cs)
COLLABORATORS
II. Set Strategy SEGMENTATION
(STP)
III. Formulate
Marketing
Programs
(4Ps)
PRODUCT
CUSTOMERS
TARGETING
PRICE
COMPANY
COMPETITION
CONTEXT
POSITIONING
ACQUISITIONRETENTION
PROMOTION
PLACE
Prof. Natalie Mizik – 2010 MIT 15.810
Sources of Customer Value
Psychological
Economic
Functional
Prof. Natalie Mizik – 2010 MIT 15.810
1. Economic Value to
Customers
EVC is the total (life-cycle) cost savings from using a
new product in place of a current product.
EVC
= (Total ownership cost of existing product)
– (Total ownership cost of new product)
Maximum
Willingness to Pay = Total
lifecycle savings from new product compared
with old product
Prof. Natalie Mizik – 2010 MIT 15.810
Example: New Telecom
Switch
Total cost of purchase
$1,000
$300 Price
Economic value
of $125
Maximum value
(at a zero price)
$375 Price
$100 Installation
$100 Installation
$400 Usage and
maintenance
$400 Usage and
maintenance
Value drivers of
new solution
Economic value
and price position
$200 Installation
$500
$500 Usage and
maintenance
$0
Benchmark
comparison
Image by MIT OpenCourseWare.
Prof. Natalie Mizik – 2010 MIT 15.810
Sources of EVC
Total cost of purchase
Price paid
Acquisition costs
Usage costs
Maintenance costs
Ownership costs
Disposal costs
Amazon.com lower purchase price with the on-line purchase of
books.
American Hospital Supply reduces a hospital's cost with a
computerized customer order program.
Sealed Air reduces labor cost in packaging with AirCap.
Saturn lowers the cost of repair and insurance through module
product design.
GE Capital works with customers to create affordable
ownership.
Rohm-Haas's Kathon MWX cuts cost of disposal of
machine fluid waste in half.
Image by MIT OpenCourseWare.
Prof. Natalie Mizik – 2010 MIT 15.810
Example
Lasik
The Canon and Lexmark printers are the
cheapest, or are they?
© source unknown. All rights reserved. This content is excluded from our Creative
Commons license. For more information, see />
Prof. Natalie Mizik – 2010 MIT 15.810
Example
A new synthetic motor oil is about to be
introduced with the primary benefit that it needs
to be changed less frequently, specifically once
every year regardless of the mileage. Assuming
current oils need to be changed every 3,000
miles at a cost of $30 per change (oil at a dollar
a quart or a total of $5 per car, labor $20,
disposal of oil $5) for an average car. What is
the EVC of the new oil to a car driver who drives
15,000 miles per year?
Prof. Natalie Mizik – 2010 MIT 15.810
EVC by Customer
Old Product
New
Product
Low Mileage
(3,000)
Average
Mileage
(15,000)
High Mileage
(45,000)
Product Price
???
1x5=5
25
15x 5 = 75
Labor Costs
20
1 x 20 = 20
100
15 x 20 = 300
Other Costs
(disposal fee)
5
1x 5 = 5
25
15 x 5 = 75
TOTAL COST
25 + price
30
150
450
EVC
5
125
425
EVC/Quart
1
25
85
Prof. Natalie Mizik – 2010 MIT 15.810
Issues in Using EVC
Customer differences
High vs. low mileage drivers.
Convincing customers
Other (fuzzy) benefits ignored
BUT, EVC can be useful in
Pricing
Segmentation
New product introduction
Prof. Natalie Mizik – 2010 MIT 15.810
What is Customer Lifetime
Value (CLV aka LTV)?
• Customer Lifetime Value
is the net present value of all
future streams of profits that a
customer generates over the life
of his/her business with the firm
Prof. Natalie Mizik – 2010 MIT 15.810
Creating or Destroying
Value?
“In the United States, top executives
lose their jobs when their companies
sell too little. In Britain, it can happen
when their companies sell too much.”
—The New York Times, March 31, 1993
Prof. Natalie Mizik – 2010 MIT 15.810
Appropriating Value
The Two Sides of Customer
Value
High
Value
of
Customers
Vulnerable
Customers
Lost
Cause
Low
Star
Customers
X
Free Riders
Low
High
Value to Customers
Creating Value
Prof. Natalie Mizik – 2010 MIT 15.810
Value of Tennis Club
Member
You own a tennis club where the annual membership
fee is $300. The average club member spends about
$100 dollars a year at the club (in balls, drinks, snacks,
etc.). The annual cost of these miscellaneous goods
(the balls, drinks, snacks, etc.) to you is $40 per
player. On average people who join a tennis club have
a playing career of 7 years. Historically, 65% of the
members in a given year rejoin the following year.
Investing capital at the going rate would earn a return
of 8% a year. Based on this information, what is the
long-term value of a customer?
Prof. Natalie Mizik – 2010 MIT 15.810
LTV Calculations
Expected
profit
Discount
factor
Expected
discounted
profit
Annual profit
Retention
Probability
Assumptions
Constant
r = .65
Year (A)
(B)
(C)
(D) = (B) x (C)
(E)
(F) = (D) x (E)
0
360
1.00
360.00
1.00
360.00
1
360
0.65
234.00
0.93
216.67
2
360
0.42
152.10
0.86
130.40
3
360
0.27
98.87
0.79
78.48
4
360
0.18
64.26
0.74
47.23
5
360
0.12
41.77
0.68
28.43
6
360
0.08
27.15
0.63
17.11
d = .08
LTV =
Prof. Natalie Mizik – 2010 MIT 15.810
878.32
Profit and Defection Patterns
Credit Card Industry
Profit Pattern
Defection Pattern
150
50
667075
42
9699105
92
86
0
0 1 2 3 4 5 6 7 8 9
-50 -40
100
100
Accounts Remain
Annual Prof
100
120
82
80
76
70
66
60
60
56
47
40
40
34
20
0
Customer Tenure
0
1
2
3
4
5
6
7
8
9
Customer Tenure
($42) *(.82) ($66) *(.76)
(m)(r) (m)(r 2 )
CLV
...
.... AC
2
2
(1 0.1)
(1 0.1)
(1 i) (1 i)
17
Prof. Natalie Mizik – 2010 MIT 15.810
Measuring Customer Value
Lifetime value of a customer assuming
infinite horizon:
r
LV m
AC
1 i r
m = margin
i = discount rate
r = retention rate
AC = acquisition cost
18
Prof. Natalie Mizik – 2010 MIT 15.810
Economics of Customer
Acquisition for FedEx
140 accounts in advertising industry use
2,285 Courier Paks (CP) per month
CP price is $12.50 and variable cost is
$4.25
Retention rate = 0.9, discount rate = 12%
What is the maximum FedEx should be
willing to spend to acquire a new account
in this industry?
Prof. Natalie Mizik – 2010 MIT 15.810
Margin Multiple
Constant Margins
r
1 i r
Retention
Rate
60%
70%
80%
90%
10%
1.20
1.75
2.67
4.50
Discount Rate
12%
14%
1.15
1.11
1.67
1.59
2.50
2.35
4.09
3.75
Prof. Natalie Mizik – 2010 MIT 15.810
16%
1.07
1.52
2.22
3.46
Margin Multiple
Growth in Margins
r
1 i r(1 g)
Retention
Rate
60%
70%
80%
90%
0%
1.15
1.67
2.50
4.09
2%
1.18
1.72
2.63
4.46
Growth Rate
4%
6%
1.21
1.24
1.79
1.85
2.78
2.94
4.89
5.42
Prof. Natalie Mizik – 2010 MIT 15.810
8%
1.27
1.92
3.13
6.08
Increasing Customer
Equity:
Three strategies:
I.
Customer acquisition (gain new customers)
II.
Customer expansion
III.
Customer retention
r
LV m
AC
1 i r
Prof. Natalie Mizik – 2010 MIT 15.810
Drivers of CLV
FIRM VALUE
Financial
Value
PROFITS &
CASH FLOW
Customer
Equity
CUSTOMER
PROFITABILITY
Drivers of
Customer
Value
CUSTOMER
ACQUISITION
CUSTOMER
RETENTION
Prof. Natalie Mizik – 2010 MIT 15.810
CUSTOMER
EXPANSION
I. Customer Acquisition
Strategies
Marketing
Affiliations
Merges and Acquisitions
E*Trade
amazon.com
AT&T
Prof. Natalie Mizik – 2010 MIT 15.810
Customer Acquisition Costs
by Marketing Activity
Source: Customer acquisition cost--a key marketing metric. Justin Zohn. NPN, National
Petroleum News, April 2003.
Prof. Natalie Mizik – 2010 MIT 15.810
Mergers & Acquisitions in the
Wireless Industry (1999-2000)
Mergers & Acquisitions in the Wireless Industry (1999-2000)
$21,639
$20,000
$15,000
$10,000
$5,000
$6,741
$7,462
$8,306
$8,550
$4,110
$-
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Cost Per Subscriber ($)
$25,000
Source: Based on data from The Industry Standard, Aug 7, 2000 and Business Week, August 7, 2000